Working Paper: CEPR ID: DP5804
Authors: Suleyman Basak; David Cass; Juan Manuel Licari; Anna Pavlova
Abstract: This paper explores the role of portfolio constraints in generating multiplicity of equilibrium. We present a simple financial market economy with two goods and two households, households who face constraints on their ability to take unbounded positions in risky stocks. Absent such constraints, equilibrium allocation is unique and is Pareto efficient. With one portfolio constraint in place, the efficient equilibrium is still possible; however, additional inefficient equilibria in which the constraint is binding may emerge. We show further that with portfolio constraints cum incomplete markets, there may be a continuum of equilibria; adding incomplete markets may lead to real indeterminacy.
Keywords: Asset Pricing; Financial Equilibrium; Indeterminacy; Multiple Equilibria; Portfolio Constraints
JEL Codes: D52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| portfolio constraints (G11) | emergence of multiple equilibria (C62) |
| portfolio constraints + incomplete markets (D52) | continuum of equilibria (D50) |
| absence of portfolio constraints (D10) | unique and Pareto efficient equilibrium (D51) |
| portfolio constraints (G11) | preservation of efficient equilibrium (D51) |
| multiple equilibria (D50) | inability to link stock price movements to economic fundamentals (G19) |