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2015•Institutional Repository (IHS Vienna)Open access

A Case for Incomplete Markets

Lawrence E. Blume, Timothy Cogley, David Easley, Thomas J. Sargent, Viktor Tsyrennikov

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Abstract

If two rational agents want to trade and there are no externalities, then trade is Pareto improving. Economists generally oppose restrictions on such trade. Complete markets allocations are Pareto optimal and thus complete markets are generally viewed as good. But when individuals want to trade because of heterogeneous beliefs, this standard argument is less compelling. We illustrate this in a standard general equilibrium setting and explore potential social benefits from restrictions on trade that make markets incomplete.

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If two rational agents want to trade and there are no externalities, then trade is Pareto improving. Economists generally oppose restrictions on such trade. Complete markets allocations are Pareto optimal and thus complete markets are generally viewed as good. But when individuals want to trade because of heterogeneous beliefs, this standard argument is less compelling. We illustrate this in a standard general equilibrium setting and explore potential social benefits from restrictions on trade that make markets incomplete.

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Available abstract

If two rational agents want to trade and there are no externalities, then trade is Pareto improving. Economists generally oppose restrictions on such trade. Complete markets allocations are Pareto optimal and thus complete markets are generally viewed as good. But when individuals want to trade because of heterogeneous beliefs, this standard argument is less compelling. We illustrate this in a standard general equilibrium setting and explore potential social benefits from restrictions on trade that make markets incomplete.

Key concepts: Incomplete markets, Financial market, Welfare, Transaction cost, Economics, Complete market, Rank (graph theory), Microeconomics

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