Discussion paper

DP6779 Asset Prices, Debt Constraints and Inefficiency

In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained inefficiency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass (1972)) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.

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Citation

Reichlin, P and G Bloise (2008), ‘DP6779 Asset Prices, Debt Constraints and Inefficiency‘, CEPR Discussion Paper No. 6779. CEPR Press, Paris & London. https://cepr.org/publications/dp6779