Fragility of Competitive Equilibrium with Risk of Default

Gaetano Bloise, Pietro Reichlin and Mario Tirelli ()

Review of Economic Dynamics, 2013, vol. 16, issue 2, 271-295

Abstract: We study competitive equilibrium in sequential economies under limited commitment. Default induces permanent exclusion from financial markets and endogenously determined solvency constraints prevent debt repudiation. Our analysis shows that such an enforcement mechanism is essentially fragile, leading to equilibrium multiplicity. We accomplish this by establishing Welfare Theorems under a weaker notion of constrained efficiency, inspired by Malinvaud, corresponding to the absence of welfare mproving feasible redistributions over finite (though indefinite) horizons. A Negishi's Method permits to show that, for any arbitrary value of social welfare in between autarchy and constrained optimality, there exists an equilibrium attaining that value. Thus, competitive equilibria might differ dramatically in terms of volumes of trade, asset price volatility, individuals' ability to insure against idiosyncratic risk and consumption inequality. (Copyright: Elsevier)

Keywords: Limited commitment; Solvency constraints; Malinvaud efficiency; Welfare Theorems; Negishi's Method; Indeterminacy; Market collapse (search for similar items in EconPapers)
JEL-codes: D50 D52 D61 E44 G13 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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DOI: 10.1010/j.red.2013.01.002

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