DP5804 Multiplicity in General Financial Equilibrium with Portfolio Constraints

Author(s): Suleyman Basak, David Cass, Juan Manuel Licari, Anna Pavlova
Publication Date: August 2006
Keyword(s): asset pricing, financial equilibrium, indeterminacy, multiple equilibria, portfolio constraints
JEL(s): D52, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5804

This paper explores the role of portfolio constraints in generating multiplicity of equilibrium. We present a simple financial market economy with two goods and two households, households who face constraints on their ability to take unbounded positions in risky stocks. Absent such constraints, equilibrium allocation is unique and is Pareto efficient. With one portfolio constraint in place, the efficient equilibrium is still possible; however, additional inefficient equilibria in which the constraint is binding may emerge. We show further that with portfolio constraints cum incomplete markets, there may be a continuum of equilibria; adding incomplete markets may lead to real indeterminacy.