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 improving 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.

Fragility of Competitive Equilibrium with Risk of Default / Gaetano, Bloise; Mario, Tirelli; Reichlin, Pietro. - In: REVIEW OF ECONOMIC DYNAMICS. - ISSN 1094-2025. - 16:2(2013), pp. 271-295. [10.1016/j.red.2013.01.002]

Fragility of Competitive Equilibrium with Risk of Default

REICHLIN, PIETRO
2013

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 improving 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.
Limited commitment Solvency constraints
Fragility of Competitive Equilibrium with Risk of Default / Gaetano, Bloise; Mario, Tirelli; Reichlin, Pietro. - In: REVIEW OF ECONOMIC DYNAMICS. - ISSN 1094-2025. - 16:2(2013), pp. 271-295. [10.1016/j.red.2013.01.002]
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/11385/67056
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