Discussion paper

DP4807 Endogenous Market Incompleteness with Investment Risks

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.

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Citation

Quadrini, V and C Meh (2004), ‘DP4807 Endogenous Market Incompleteness with Investment Risks‘, CEPR Discussion Paper No. 4807. CEPR Press, Paris & London. https://cepr.org/publications/dp4807