Endogenous Market Incompleteness with Investment Risks

33 Pages Posted: 4 Apr 2005

See all articles by Césaire Assah Meh

Césaire Assah Meh

Government of Canada - Department of Monetary and Financial Analysis

Vincenzo Quadrini

University of Southern California - Marshall School of Business - Finance and Business Economics Department; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: December 2004

Abstract

This Paper studies a general equilibrium economy in which agents have the ability to invest in a risky technology. The investment risk cannot be fully insured with optimal contracts because shocks are private information. We show that the presence of investment risks leads to under-accumulation of capital relative to an economy where idiosyncratic shocks can be fully insured. We also show that the availability of state-contingent (optimal) contracts - compared to simple debt contracts - brings the aggregate stock of capital close to the complete markets level. Institutional reforms that make possible the use of these contracts have important welfare consequences.

Keywords: Asymmetric information, optimal contracts, aggregate capital

JEL Classification: D58, D82, E20

Suggested Citation

Meh, Césaire Assah and Quadrini, Vincenzo, Endogenous Market Incompleteness with Investment Risks (December 2004). CEPR Discussion Paper No. 4807. Available at SSRN: https://ssrn.com/abstract=697941

Césaire Assah Meh

Government of Canada - Department of Monetary and Financial Analysis ( email )

Ottawa, Ontario K1A 0G9
Canada
613-782-7564 (Phone)
613-782-7508 (Fax)

Vincenzo Quadrini (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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