DP4807 Endogenous Market Incompleteness with Investment Risks
|Author(s):||Césaire A. Meh, Vincenzo Quadrini|
|Publication Date:||December 2004|
|Keyword(s):||Aggregate Capital, Asymmetric Information, optimal contracts|
|JEL(s):||D58, D82, E20|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4807|
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.