Risk-Sharing, Investment, and Asset Prices According to Cournot and Arrow-Debreu

66 Pages Posted: 24 Jan 2019 Last revised: 30 Mar 2020

See all articles by Daniel Neuhann

Daniel Neuhann

University of Texas at Austin, McCombs School of Business

Michael Sockin

University of Texas at Austin - Red McCombs School of Business

Date Written: August 7, 2019

Abstract

We provide a tractable framework for analyzing how large traders with price impact affect risk-sharing, capital allocation, and asset prices in a production economy with complete security markets. Our approach offers a novel characterization of strategic interactions under non-linear price impact, and provides simple formulas for measuring the welfare cost of strategic trading. The central economic mechanism is that privately-optimal quantity distortions raise the cost of insuring idiosyncratic risk, giving rise to a novel strategic externality. This has real effects consistent with recent macroeconomic trends: aggregate investment falls relative to the competitive benchmark, there is cross-sectional misallocation that lowers TFP, and there is a simultaneous compression of the risk-free rate and the risk premium. Comparative statics show price impact is particularly distortionary when idiosyncratic risk is high and risk attitudes are dispersed, as in recessions.

Keywords: risk-sharing, market power, asset prices, investment, productivity, financial intermediaries, concentrated financial markets, price impact,

JEL Classification: E22, E44, G11, G12, G20

Suggested Citation

Neuhann, Daniel and Sockin, Michael, Risk-Sharing, Investment, and Asset Prices According to Cournot and Arrow-Debreu (August 7, 2019). Available at SSRN: https://ssrn.com/abstract=3320035 or http://dx.doi.org/10.2139/ssrn.3320035

Daniel Neuhann (Contact Author)

University of Texas at Austin, McCombs School of Business ( email )

Austin, TX 78701
United States

Michael Sockin

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

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