A Market Based Solution to Price Externalities: A Generalized Framework

Weerachart Kilenthong and Robert Townsend

No 20275, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Pecuniary externalities have regained the interest of researchers as they seek policy interventions and regulations to remedy externality-induced distortions, e.g., balance sheet effects, amplifiers and fire sales. In this paper we go back to first principles and show how to design financial contracts and markets in such a way that ex ante competition can achieve a constrained-efficient allocation. The key as in general equilibrium theory is to extend the commodity space in such a way that bundling, exclusivity and additional markets internalize these pecuniary externalities. We devise in this paper a general way of proceeding that covers as a general case the large variety of example-economies which differ from one another in the particular source of the constraint generating the externality. A key take away from our approach is that we do not need to identify and quantify some policy intervention. With the appropriate ex ante design we can let markets solve the problem.

JEL-codes: D52 D53 D61 D62 (search for similar items in EconPapers)
Date: 2014-07
Note: DEV IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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