Pareto improving financial innovation in incomplete markets |
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Authors: | David Cass Alessandro Citanna |
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Institution: | (1) Economics Department, European University Institute, Badia Fiesolana, San Domenico di Fiesole, I-50016 Firenze, ITALY, IT;(2) GSIA, Carnegie Mellon University, Pittsburgh, PA 15213, USA, US |
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Abstract: | Summary. In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete
markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments
and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness
is sufficiently larger than the extent of household heterogeneity, S−I≥2H−1 resp. S−I≥H+1], there is an open set of single assets resp. pairs of assets] whose introduction can make every household better off
(and, symmetrically, an open set of single assets resp. pairs of assets] whose introduction can make them all worse off ).
We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a
procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite
useful in other applications involving smooth analysis.
Received: August 14, 1995; revised version: April 14, 1997 |
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Keywords: | JEL Classification Numbers: C60 D60 G10 D52 |
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