Dynamic Aggregation and Computation of Equilibria in Finite-Dimensional Economies with Incomplete Financial Markets

Domenico Cuoco and Hua H.

No RPF-236, Research Program in Finance Working Papers from University of California at Berkeley

Abstract: This paper constructs a representative agent supporting the equilibrium allocation in event-tree economies with time-additive preferences and possibly incomplete securities markets. If the equilibrium allocation is Pareto optimal, this construction gives the usual linear welfare function. Otherwise, the representative agent's utility function is state-dependent, even when individual agents have state-independent utilities and homogeneous beliefs. The existence of a representative agent allows us to provide a characterization of equilibria which does not rely on the derivation of the agents' intertemporal demand functions for consumption and investment. More specifically, it allows us to transform the dynamic general equilibrium problem into a static one, and is therefore especially well suited for numerical computation of equilibria in economies with incomplete financial markets.

Date: 1994-06-01
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