Welfare-Improving Financial Innovation with a Single Good

Posted: 5 Jan 1999

See all articles by Ronel Elul

Ronel Elul

Federal Reserve Bank of Philadelphia

Abstract

We show that at any equilibrium of almost every single-good incomplete markets economy, it is possible to find an asset which when introduced makes every agent better-off. Diamond (1967) has shown, however, that such economies are constrained suboptimal, so it is of course impossible to find a new asset which makes all agents worse-off. This contrasts with the case of multiple consumption goods, for which Cass and Citanna (1995) and Elul (1995) demonstrate that equilibrium utilities may be arbitrarily perturbed via financial innovation. Proving our result requires us to exploit not changes in equilibrium prices, but rather the gains to trading the new asset. In particular, we find an asset which when introduced does not change the existing asset prices even though it is traded by every agent--by a revealed preference argument it must therefore make everyone better-off.

JEL Classification: D52, D60, G10

Suggested Citation

Elul, Ronel, Welfare-Improving Financial Innovation with a Single Good. Economic Theory, Vol. 13, Iss. 1, 1999, Available at SSRN: https://ssrn.com/abstract=142436

Ronel Elul (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
United States
215-574-3965 (Phone)

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