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Complete Markets, Enforcement Constraints and Intermediation

Author

Listed:
  • Arpad Abraham

    (University of Rochester)

  • Eva Carceles-Poveda

    (SUNY at Stony Brook)

Abstract

Alvarez and Jermann (2000) show that the constrained efficient allocations of endowment economies with complete markets and limited commitment can be decentralized with endogenous borrowing limits on the Arrow securities. In a model with capital accumulation, aggregate risk and competitive intermediaries, we show that such a decentralization is not possible unless one imposes an upper limit on the intermediaries' capital holdings. Since there is no empirical evidence of such restrictions, we also characterize the equilibrium with no capital accumulation constraints. We show that this allocation solves a similar system of equations to the one of the constrained optimal solution, a result which considerably simplifies the equilibrium computation. In addition, capital accumulation is higher in this case, since the intermediaries do not internalize that fact that a higher aggregate capital increases the incentives to default. Finally, this also implies that agents may enjoy a higher welfare in the long run in spite of the fact that this allocation is not constrained efficient

Suggested Citation

  • Arpad Abraham & Eva Carceles-Poveda, 2006. "Complete Markets, Enforcement Constraints and Intermediation," Computing in Economics and Finance 2006 320, Society for Computational Economics.
    • Handle: RePEc:sce:scecfa:320
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    File URL: http://repec.org/sce2006/up.13289.1141084531.pdf
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    References listed on IDEAS

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    Cited by:

    1. Tobias Broer, 2013. "The Wrong Shape of Insurance? What Cross-Sectional Distributions Tell Us about Models of Consumption Smoothing," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(4), pages 107-140, October.
    2. Krueger, Dirk & Perri, Fabrizio, 2011. "Public versus private risk sharing," Journal of Economic Theory, Elsevier, vol. 146(3), pages 920-956, May.

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    More about this item

    Keywords

    Complete markets; Enforcement Constraints; Intermediation;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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