The poor are twice cursed: Wealth inequality and inefficient credit market

This paper investigates the role of unobservable wealth differences on credit market equilibrium, given there is also asymmetric information concerning effort preferences and choices. In equilibrium, poor but able entrepreneurs may subsidise the rich and incompetent or be excluded. As a result, investment may exceed or fall short of the optimal level. Low inequality may deliver conditions for perfect screening and an efficient level of investment. The equilibrium with cross subsidisation is consistent with otherwise puzzling empirical observations.     

Diffidence Theorem, State-Dependent Preferences, and DARA

C. Gollier (The Economics of Risk and Time. Cambridge: MIT Press, 2001) has developed a standard technique based on the diffidence theorem. This theorem provides a very simple instrument to solve relatively sophisticated problems when preferences are state-independent. The object of this article is to show that the theorem is also very useful to derive significant results with state-dependent preferences. Using the reference set notion and an extension of the diffidence theorem, we establish formally necessary and sufficient conditions on the reference set, in order to obtain prudence and decreasing absolute risk aversion. Examples of DARA utility functions compatible with non-linear reference sets are presented in the Appendix.     

On the Characterisation of Investor Preferences by Changes in Wealth

As wealth increases, preference of one fixed gamble over another typically changes once or not at all. A key question is whether certain assumptions on preferences guarantee such behaviour. Bell [Management Science, 34(12), 1416–1424, 1988; 41, 1145–1150, 1995a; 41(1), 23–30, 1995b] has addressed this difficult question and characterised the specific functional form of utility functions which allow a finite number of switches between two arbitrary gambles over the entire range of initial wealth. By extending this analysis, and linking the discussion to more recent works, the authors characterise conditions under which a large set of utility functions with respect to their switching characteristics, and discuss the results in the context of the classical notion of decreasing absolute risk aversion.