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Financial intermediation and the welfare theorems in incomplete markets


Bettzüge, Marc Oliver; Hens, Thorsten; Zierhut, Michael (2022). Financial intermediation and the welfare theorems in incomplete markets. Economic Theory, 73(2-3):457-486.

Abstract

In production economies with incomplete markets, shareholders disagree about the objective of the firm. We show that a weak financial intermediary, who is unable to complete markets, can offer just enough spanning to resolve this disagreement. The intermediary is limited to offering one customized contract per consumer. Knowledge of demand functions is sufficient for offering the right contracts. Once agreement among shareholders is reached, productive efficiency is restored, which in turn permits a Pareto efficient market outcome. This result shows that the first welfare theorem does not depend on complete spanning, but merely on institutions that provide the right span. However, this cannot be said about the second welfare theorem: For some wealth distributions, equilibria with transfers fail to exist due to nonconvexities caused by market incompleteness.

Abstract

In production economies with incomplete markets, shareholders disagree about the objective of the firm. We show that a weak financial intermediary, who is unable to complete markets, can offer just enough spanning to resolve this disagreement. The intermediary is limited to offering one customized contract per consumer. Knowledge of demand functions is sufficient for offering the right contracts. Once agreement among shareholders is reached, productive efficiency is restored, which in turn permits a Pareto efficient market outcome. This result shows that the first welfare theorem does not depend on complete spanning, but merely on institutions that provide the right span. However, this cannot be said about the second welfare theorem: For some wealth distributions, equilibria with transfers fail to exist due to nonconvexities caused by market incompleteness.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
03 Faculty of Economics > Department of Economics
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Economics and Econometrics
Uncontrolled Keywords:Economics and Econometrics
Scope:Discipline-based scholarship (basic research)
Language:English
Date:1 April 2022
Deposited On:16 Aug 2021 14:55
Last Modified:26 May 2024 01:42
Publisher:Springer
ISSN:0938-2259
Additional Information:Financial Economics
OA Status:Hybrid
Free access at:Publisher DOI. An embargo period may apply.
Publisher DOI:https://doi.org/10.1007/s00199-020-01294-w
Official URL:https://link.springer.com/article/10.1007/s00199-020-01294-w
Other Identification Number:merlin-id:19549
  • Content: Published Version
  • Licence: Creative Commons: Attribution 4.0 International (CC BY 4.0)