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A microfoundation for incomplete security markets

Author

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  • Harold L. Cole
  • Narayana R. Kocherlakota

Abstract

We consider a simple environment in which individuals receive income shocks that are unobservable to others and can privately store resources. We show that this ability to privately store can undercut the ability to shift resources across individuals to the extent that the efficient allocation only involves consumption smoothing over time, as opposed to insurance (consumption smoothing over states) if the rate of return on savings is not too far below the rate of time preference, or, alternatively, if the worst possible outcome is sufficiently dire. We also show that unlike environments without unobservable storage, the symmetric efficient allocation is decentralizable through a competitive asset market in which individuals trade risk-free bonds among themselves.

Suggested Citation

  • Harold L. Cole & Narayana R. Kocherlakota, 1997. "A microfoundation for incomplete security markets," Working Papers 577, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmwp:577
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    Citations

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    Cited by:

    1. Khan, Aubhik & Ravikumar, B., 2001. "Growth and risk-sharing with private information," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 499-521, June.
    2. Per Krusell & Anthony A. Smith, Jr., 1999. "On the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 245-272, January.

    More about this item

    Keywords

    Securities;

    Statistics

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