Pareto Improving Financial Innovation in Incomplete Markets

David Cass and Alessandro Citanna
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Alessandro Citanna: GSIA, Carnegie Mellon University - CMU - Carnegie Mellon University [Pittsburgh]

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Abstract: In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S−I≥2H−1 [resp. S−I≥H+1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off ). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.

Keywords: financial innovation; incomplete markets; Pareto (search for similar items in EconPapers)
Date: 1998-04
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Citations: View citations in EconPapers (73)

Published in Economic Theory, 1998, Vol.11,n°3, pp.467-494. ⟨10.1007/s001990050198⟩

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Journal Article: Pareto improving financial innovation in incomplete markets (1998)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00479286

DOI: 10.1007/s001990050198

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