Default and Punishment in General Equilibrium

36 Pages Posted: 8 Dec 2003

See all articles by Pradeep K. Dubey

Pradeep K. Dubey

SUNY Stony Brook - Center for Game Theory in Economics

John Geanakoplos

Yale University; Santa Fe Institute

Martin Shubik

Yale University - School of Management; Yale University - Cowles Foundation

Multiple version iconThere are 3 versions of this paper

Date Written: November 2003


We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment by thinking of assets as pools. 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 in a perfectly competitive, general equilibrium framework.

Perfect competition eliminates the need for lenders to compute how the size of their loan or the price they quote might affect default rates. It also makes for a simple equilibrium refinement, which we propose in order to rule out irrational pessimism about deliveries of untraded assets.

We show that refined equilibrium always exists in our model, and that default, in conjunction with refinement, opens the door to a theory of endogenous assets. The market chooses the promises, default penalties, and quantity constraints of actively traded assets.

Note: A previous version of this paper can be found at:

Keywords: Default, incomplete markets, adverse selection, moral hazard, equilibrium refinement, endogenous assets

JEL Classification: D4, D5, D8, D41, D52, D81, D82

Suggested Citation

Dubey, Pradeep K. and Geanakoplos, John D and Shubik, Martin, Default and Punishment in General Equilibrium (November 2003). Available at SSRN:

Pradeep K. Dubey

SUNY Stony Brook - Center for Game Theory in Economics ( email )

Stony Brook, NY 11794
United States
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John D Geanakoplos (Contact Author)

Yale University ( email )

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Santa Fe Institute ( email )

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Martin Shubik

Yale University - School of Management ( email )

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Yale University - Cowles Foundation ( email )

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