Endogenous Market Incompleteness with Investment Risks

Vincenzo Quadrini and Cesaire Meh

No 4807, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: 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.

Keywords: Asymmetric information; Optimal contracts; Aggregate capital (search for similar items in EconPapers)
JEL-codes: D58 D82 E20 (search for similar items in EconPapers)
Date: 2004-12
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-mic
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Citations: View citations in EconPapers (6)

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Journal Article: Endogenous market incompleteness with investment risks (2006)
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