Patience, Persistence, and Welfare Costs of Incomplete Markets in Open Economies

30 Pages Posted: 23 Apr 2001

See all articles by Jinill Kim

Jinill Kim

Korea University

Sunghyun Henry Kim

Sungkyunkwan University - Department of Economics

Andrew T. Levin

affiliation not provided to SSRN

Date Written: March 2001

Abstract

In this paper, we investigate the welfare implications of alternative financial market structures in a two-country endowment economy model. In particular, we obtain an analytic expression for the expected lifetime utility of the representative household when sovereign bonds are the only internationally traded asset, and we compare this welfare level with that obtained under complete asset markets. The welfare cost of incomplete markets is negligible if agents are very patient and shocks are not very persistent, but this cost is dramatically larger if agents are relatively impatient and shocks are highly persistent. For realistic cases in which agents are very patient and shocks are highly persistent (that is, the discount factor and the first-order autocorrelation are both near unity), the welfare cost of incomplete markets is highly sensitive to the specific values of these parameters. Finally, using a non-linear solution algorithm, we confirm that a two-country production economy with endogenous labor supply has qualitatively similar welfare properties.

Keywords: International risk sharing, financial market structure

JEL Classification: F41, D52

Suggested Citation

Kim, Jinill and Kim, Sunghyun Henry and Levin, Andrew, Patience, Persistence, and Welfare Costs of Incomplete Markets in Open Economies (March 2001). Available at SSRN: https://ssrn.com/abstract=266493 or http://dx.doi.org/10.2139/ssrn.266493

Jinill Kim (Contact Author)

Korea University ( email )

1 Anam-dong 5 ka
Seoul, 136-701

Sunghyun Henry Kim

Sungkyunkwan University - Department of Economics ( email )

110-745 Seoul
Korea

Andrew Levin

affiliation not provided to SSRN

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