A Unified Approach to Market Incompleteness

48 Pages Posted: 2 Jun 2007

See all articles by Semyon Malamud

Semyon Malamud

Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Eugene Trubowitz

Swiss Federal Institute of Technology Zurich

Date Written: May 15, 2007

Abstract

We introduce a general class of incomplete markets that includes almost all well known examples of market incompleteness in finance and macroeconomics. Two concrete examples are the problem of idiosyncratic income shocks and general, diffusion driven incompleteness. For all markets in this class we explicitly solve the associated utility maximization problem by a recursive construction and derive many important properties. For example, precautionary savings and the diminishing marginal propensity to consume. Effectively, the class is characterized by these two economic properties. We also prove that the growth rate of consumption is always larger when markets are incomplete and that precautionary savings are monotone increasing in the size of idiosyncratic risk. Our construction can be implemented computationally by an efficient, robust numerical scheme.

Keywords: incomplete markets, idiosyncratic risk, precautionary saving, investment, marginal propensity to consume

JEL Classification: G11, E21, D91, D81

Suggested Citation

Malamud, Semyon and Trubowitz, Eugene, A Unified Approach to Market Incompleteness (May 15, 2007). Available at SSRN: https://ssrn.com/abstract=990328 or http://dx.doi.org/10.2139/ssrn.990328

Semyon Malamud (Contact Author)

Ecole Polytechnique Federale de Lausanne ( email )

Lausanne, 1015
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Eugene Trubowitz

Swiss Federal Institute of Technology Zurich ( email )

Lausanne CH-1001
Switzerland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
197
Abstract Views
1,200
Rank
296,183
PlumX Metrics