Constrained suboptimality in incomplete markets: a general approach and two applications

Abstract

In this paper we re-examine generic constrained suboptimality of equilibrium allocations with incomplete numeraire asset markets. We provide a general framework which is capable of resolving some issues left open by the previous literature, and encompasses many kinds of intervention in partially controlled market economies. In particular, we establish generic constrained suboptimality, as studied by Geanakoplos and Polemarchakis, even without an upper bound on the number of households. Moreover, we consider the case where asset markets are left open, and the planner can make lump-sum transfers in a limited number of goods. We show that such a perfectly anticipated wealth redistribution policy, though consistent with the assumed incomplete financial structure, is typically effective

Constrained suboptimality when prices are non-competitive

“…Geanakoplos and Polemarchakis (1986) show that competitive equilibria are typically constrained suboptimal, by showing that Pareto improvements can be obtained by making the appropriate redistributions in households' initial asset portfolios and next restricting all trade in asset markets. More recently, similar results have been obtained that show the possibility of generating Pareto improvements by introducing new financial assets, see Cass andCitanna (1998), or Citanna et al (1998) for a more general perspective, and the possibility of generating Pareto improvements by price regulation, see Polemarchakis (1979); Drèze and Gollier (1993); Drèze (2001), and Herings and Polemarchakis (2005).…”

Quantifying the Cost of Risk in Consumption

“…9 Thus, risk in our analysis is the consequence of the fact that individuals' income is subject to "shocks" over a long time horizon; and these shocks cause individuals to change their position in the cross-sectional income and consumption distribution. We keep our application simple by letting aside the analysis on how risk in income mobility translates into risk in consumption mobility, and directly focus on consumption risk and its micro cost.…”

Proportional Transaction Costs On Asset Trades: A Note On Existence By Homotopy Methods

“…Bid-ask spreads or transaction costs are adjusted more slowly than asset payo¤s or changes in expectations relative to asset payo¤s, due to information arrival. With multiple market makers, it may happen that 2 For instance, Harris and Schultz (1997) report that Nasdaq's SOES for trading displays as a regular problem the presence of arbitrageurs called SOES bandits by market makers. These traders 'make money by spotting minor pricing discrepancies', and by executing trades across market makers.…”