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Welfare-improving financial innovation with a single good

Author

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  • Ronel Elul

    (Department of Economics, Brown University, Providence, RI 02912, USA)

Abstract

We show that at any equilibrium of almost every single-good incomplete markets economy, it is possible to find an asset which when introduced makes every agent better-off. Diamond (1967) has shown, however, that such economies are constrained suboptimal, so it is of course impossible to find a new asset which makes all agents worse-off. This contrasts with the case of multiple consumption goods, for which Cass and Citanna (1995) and Elul (1995) demonstrate that equilibrium utilities may be arbitrarily perturbed via financial innovation. Proving our result requires us to exploit not changes in equilibrium prices, but rather the gains to trading the new asset. In particular, we find an asset which when introduced does not change the existing asset prices even though it is traded by every agent - by a revealed preference argument it must therefore make everyone better-off.

Suggested Citation

  • Ronel Elul, 1999. "Welfare-improving financial innovation with a single good," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 13(1), pages 25-40.
    • Handle: RePEc:spr:joecth:v:13:y:1999:i:1:p:25-40
    Note: Received: May 28, 1997; revised version: July 1, 1997
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    Cited by:

    1. Christophe Prechac & Aditya Goenka, 2004. "Are Sunspots Inevitable?," Econometric Society 2004 Far Eastern Meetings 786, Econometric Society.

    More about this item

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D60 - Microeconomics - - Welfare Economics - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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