Abstract not found

We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of adverse selection and signalling phenomena (including the Akerlof lemons model and the Rothschild—Stiglitz insurance model) in a general equilibrium framework. Despite earlier claims about the nonexistence of equilibrium with adverse selection, we show that equilibrium always exists. We show that more lenient punishment which encourages default may be Pareto improving because it increases the dimension of the asset span without increasing the number of assets traded. We deÞne an equilibrium reÞnement that requires expected delivery rates for untraded assets to be reasonably optimistic. Default, in conjunction with this reÞnement, opens the door to a theory of endogenous assets. The market chooses the promises, default penalties, and quantity constraints of actively traded assets.

Do Walrasian markets function orderly in the presence of adverse selection? In particular, is their outcome efficient? This paper addresses these questions in the context of a Rothschild and Stiglitz insurance economy. We identify an externality associated with the presence of adverse selection as a special form of consumption externality. Consequently, we show that while competitive equilibria always exist, they are not typically incentive efficient. However, as markets for pollution rights can internalize environmental externalities, markets for consumption rights can be designed so as to internalize the consumption externality due to adverse selection. Markets for consumption rights amount to requiring that firms offering contracts designated for the ‘low risk types’ acquire the right to do so, at market-determined prices, from agents declaring to be of ’high risk’. With such markets competitive equilibria exist, are always incentive efficient and any incentive efficient allocation can be decentralized as a competitive equilibrium.

McGill, and Penn State University, and three anonymous referees for helpful comments on earlier drafts. A security design model shows that multinational firms needing to finance their operations should issue different securities to investors in different countries in order to aggregate their disparate information about domestic and foreign cash flows. However, if the firm becomes bankrupt, investors may face uncertain costs of reorganizing assets in a foreign country and thus may value foreign assets at their average value. This penalizes superior firms with low reorganization costs. Such firms minimize the adverse selection penalty by designing securities that allocate all the cash flow in bankruptcy to investors for which the adverse selection costs are the smallest given the exchange rate. We show that this sharing rule can be implemented with currency swaps because these instruments allow the priorities of claims in bankruptcy to switch depending on the exchange rate. I.

We study a general equilibrium model with production where financial markets are incomplete. At a competitive equilibrium firms take their production and financial decisions so as to maximize their value. We show that shareholders unanimously support value maximization. Furthermore, competitive equilibria are constrained Pareto efficient. Finally the Modigliani-Miller theorem typically does not hold and the firms’ corporate financing structure is determined at equilibrium. Such results extend to the case where informational asymmetries are present and contribute to determine the firms ’ capital structure.

We are grateful to Sushil Bikhchandani,Tony Bernardo,John Cochrane (the editor),Peter DeMarzo,John Riley,and seminar participants at UBC,UC Irvine,UCLA,University of Colorado at Boulder,McGill,and Penn State University,and three anonymous referees for helpful comments on earlier drafts. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of adverse selection, and signalling phenomena (including the Akerlof lemons model and Rothschild—Stiglitz insurance model) and some moral hazard problems in a general equilibrium framework. Despite earlier claims about the nonexistence of equilibrium with adverse selection, we show that equilibrium always exists. We show that more lenient punishment which encourages default may be Pareto improving because it allows for better risk spreading. We deÞne an equilibrium reÞnement that requires expected delivery rates for untraded assets to be reasonably optimistic. Default, in conjunction with this reÞnement, opens the door to a theory of endogenous assets. The market can choose default penalties and quantity constraints on sellers.

This paper analyzes an incomplete …nancial markets model with pricetaking utility-maximizing …nancial innovators and no-short sales restrictions. It is shown that, given the indeterminacy of the no arbitrage price conjecture of innovators, …nancial markets can remain incomplete in equilibrium. As a consequence, real indeterminacy of degree at least equal to int (S/2)(S-(S/2)) results, where S is the number of spots in the future. The dimension of innovators ’ beliefs giving rise to I newly introduced …nancial assets is I(S-I), with an equal degree of real indeterminacy. 1.

Summary. We study a financial market economy with a continuum of borrowers and pooling of borrowers ’ promises. Under these conditions and in the absence of designing costs, utility-maximizing decisions of price-taking borrowers may lead to financial market incompleteness. Parametrizing equilibria through the borrowers’ no-arbitrage beliefs, we link expectations to the financial market structure. Markets are complete if and only if borrowers ’ beliefs are homogeneous. Price-taking behavior causes a coordination problem which in turn yields indeterminacy and inefficiency of equilibrium allocations.

In this paper I present a model where an informed …nancial issuer of a new security decides whether to reveal payo¤-relevant information to investors. The main result is that, if information is not revealed, and consumers have biased expectations about payo¤s then they might not buy the new securities. I also characterize the value of information revelation for the …nancial intermediary I show that when the intermediary is risk averse the value is always positive if revealing is costless. Otherwise the incentives to publish it (and to issue the new securities) depend upon the cost of disclosing information.