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Constrained Efficiency with Adverse Selection and Directed Search

S. Mohammad R. Davoodalhosseini ()

Staff Working Papers from Bank of Canada

Abstract: Constrained efficient allocation (CE) is characterized in a model of adverse selection and directed search (Guerrieri, Shimer, and Wright (2010)). CE is defined to be the allocation that maximizes welfare, the ex-ante utility of all agents, subject to the frictions of the environment. When equilibrium does not achieve the first best (the allocation that maximizes welfare under complete information), then welfare in the CE is strictly higher than welfare in the equilibrium allocation. That is, equilibrium is not constrained efficient. Under some conditions, welfare in the CE even attains welfare in the first best. Finally, sufficient conditions are provided under which equilibrium is not constrained Pareto efficient, either. Cross-subsidization is the key to all these results. In an asset market application, the first best is shown to be implementable through tax schedules that are monotone in the asset prices.

Keywords: Economic models; Financial markets; Financial system regulation and policies; Market structure and pricing (search for similar items in EconPapers)
JEL-codes: D82 D83 E24 G1 J31 J64 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mic
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3) Track citations by RSS feed

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:17-15

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