Default and Punishment in General Equilibrium

Pradeep Dubey, John Geanakoplos () and Martin Shubik
Additional contact information
Pradeep Dubey: SUNY, Stony Brook
John Geanakoplos: Yale University, Cowles Foundation, http://cowles.econ.yale.edu/faculty/geanakoplos.htm

No 1304R5, Cowles Foundation Discussion Papers from Cowles Foundation, Yale University

Abstract: We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment by thinking of assets as pools. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of adverse selection and signalling phenomena in a perfectly competitive, general equilibrium framework. Perfect competition eliminates the need for lenders to compute how the size of their loan or the price they quote might affect default rates. It also makes for a simple equilibrium refinement, which we propose in order to rule out irrational pessimism about deliveries of untraded assets. We show that refined equilibrium always exists in our model, and that default, in conjunction with refinement, opens the door to a theory of endogenous assets. The market chooses the promises, default penalties, and quantity constraints of actively traded assets.

Keywords: Default; incomplete markets; adverse selection; moral hazard; equilibrium refinement; endogenous assets (search for similar items in EconPapers)
JEL-codes: D4 D5 D8 D41 D52 D81 D82 (search for similar items in EconPapers)
Date: 2001-05, Revised 2004-03
Note: CFP 1108.
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Published in Econometrica (2005), 73(1): 1-37

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Related works:
Working Paper: Default and Punishment in General Equilibrium (2001)
Working Paper: Default and Punishment in General Equilibrium (2001)
Journal Article: Default and Punishment in General Equilibrium (2005)
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