General equilibrium with endogenous securities and moral hazard

Abstract

This paper studies a class of general equilibrium economies in which the individuals’ endowments depend on privately observed effort choices and the financial markets are endogenous. The environment is modeled as a two-stage game. Individuals first make strategic financial-innovation decisions. They then act in a Radner-type economy with the previously designed securities. Consumption goods, portfolios, and effort levels are chosen competitively (i.e., taking prices as given). An equilibrium concept is adapted for these moral hazard economies and its existence is proven. It is shown through an example how incentive motives might lead to the endogenous emergence of financial incompleteness. Copyright Springer-Verlag Berlin/Heidelberg 2005General equilibrium, Moral hazard, Endogenous incomplete markets, Non-exclusive securities.,

Equilibrium in Risk-Sharing Games

“…Mixture of strategic and competitive stages has also been used in models with asymmetric information. For instance, in [Bra05] a two-stage equilibrium game is used to model security design among agents with private information regarding their effort. In a first stage, agents strategically issue novel financial securities; in the second stage, equilibrium on the issued securities is formed competitively.…”

When Financial Imperfections Are Not the Problem, But the Solution

“…He shows that, given the assumptions of Bertrand competition and exclusivity, an equilibrium exists and is constrained optimal. On the other hand, Braido [6] presents a general equilibrium model as a two-stage game where agents act as producers, as consumers and as financial intermediaries with intermediation costs. Each individual is allowed to design a financial structure that consists of specifying securities pay-offs in each state and transaction constraints that restrict the participation of some agents in some markets, while allowing for non-exclusivity.…”

“…The inefficiency of equilibria in economies with moral hazard and non-exclusive contracts has been extensively studied by Helpman and Laffont [19], Arnott and Stiglitz [3], Bisin and Guaitoli [5] and Kahn and Mookherjee [20], where the main conclusion is that exclusivity is necessary for constrained efficiency of equilibria. It is important to point out the relevance of the work of Braido [6] for our model. To show how markets can be endogenously incomplete in equilibrium and how this might be optimal, he offers an example with two agents where only one of them is risk averse.…”

“…In period 0, agents receive an endowment of a single consumption good. In period 1, there is uncertainty regarding endowments: there are (only) two states of the world, which we denote by s = 1, 2, and agents receive an endowment e i s of the the consumption good in state s. 6 Rather than being exogenous, the probabilities of the two states depend on some action of agent 0. In period 0, he has the choice of exerting costly effort, ε, which makes state 1 more likely.…”

General Equilibrium and Endogenous Creation of Asset Markets

“…We remark that our tool can be applied also in other approaches, for instance, exchange economies where assets are designed by consumers. The models of Braido [9] and Faias[PhD diss] are examples of this class of economies.…”