Does Market Incompleteness Matter?

Econometrica · 2002 · Volume 70 · Issue 5

Abstract

This paper argues that incompleteness of intertemporal financial markets has little effect (on welfare, prices, or consumption) in an economy with a single consumption good, provided that traders are long–lived and patient, a riskless bond is traded, shocks are transitory, and there is no aggregate risk. In an economy with aggregate risk, a similar conclusion holds, provided traders share the same CRRA utility function and the right assets are traded. Examples demonstrate that these conclusions need not hold if the wrong assets are traded or if the economy has multiple consumption goods.

Keywords

infinite horizon economies, incomplete markets, law of large numbers, consumption smoothing, permanent income hypothesis

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