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Computing Equilibria in Finance Economies with Incomplete Markets and Transaction Costs

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  • Herings P. Jean-Jacques
  • Schmedders Karl

    (METEOR)

Abstract

Transaction costs in financial markets may have important consequences for volumes of trade, asset pricing and welfare. In the economic literature they are often given as one reason for the incompleteness of asset markets, which is a striking example of their potential impact on volumes of trade. We argue that analytical results on the impact of transaction costs are hard to obtain and a computational approach is needed. This paper introduces the first algorithm for the computation of equilibria in the general equilibrium model with incomplete asset markets and linear transaction costs on the financial markets. The algorithm is based on the homotopy principle and is able to deal with the two major technical difficulties of the model, namely the existence of non-differentiabilities of agents'' asset demands as a function of the asset prices and the existence of locally non-unique equilibria. Several numerical examples give a first glimpse of the impact of transaction costs on the nature of the equilibria. We show that the consequences of transaction costs for volumes of trade and prices can be counterintuitive even for small economic models.

Suggested Citation

  • Herings P. Jean-Jacques & Schmedders Karl, 2000. "Computing Equilibria in Finance Economies with Incomplete Markets and Transaction Costs," Research Memorandum 049, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  • Handle: RePEc:unm:umamet:2000049
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    References listed on IDEAS

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    Cited by:

    1. Carosi, Laura & Gori, Michele & Villanacci, Antonio, 2009. "Endogenous restricted participation in general financial equilibrium," Journal of Mathematical Economics, Elsevier, vol. 45(12), pages 787-806, December.
    2. Gori, Michele & Pireddu, Marina & Villanacci, Antonio, 2013. "Regularity and Pareto improving on financial equilibria with price-dependent borrowing restrictions," Research in Economics, Elsevier, vol. 67(1), pages 100-110.
    3. Martins-da-Rocha, Victor Filipe & Vailakis, Yiannis, 2008. "Endogenous Transaction Costs," FGV/EPGE Economics Working Papers (Ensaios Economicos da EPGE) 680, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
    4. Marko Backovic & Zoran Popovic, 2012. "The Analysis Of Model Of General Economic Equilibrium And Financial Instability Of Economic System," Montenegrin Journal of Economics, Economic Laboratory for Transition Research (ELIT), vol. 8(1), pages 63-85.
    5. Buss, Adrian & Dumas, Bernard J, 2013. "Financial-market Equilibrium with Friction," CEPR Discussion Papers 9524, C.E.P.R. Discussion Papers.
    6. Michele Gori & Marina Pireddu & Antonio Villanacci, 2010. "Regularity and Pareto Improving on financial equilibria with endogenous borrowing restrictions," Working Papers - Mathematical Economics 2010-08, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa, revised Aug 2012.
    7. V. Martins-da-Rocha & Yiannis Vailakis, 2010. "Financial markets with endogenous transaction costs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 45(1), pages 65-97, October.

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