Document Type
Discussion Paper
Publication Date
7-1-1988
CFDP Number
879R
CFDP Revision Date
1989-02-01
CFDP Pages
37
Abstract
We extend the standard model of general equilibrium with incomplete markets (GEI) to allow for default. Default can be either strategic, or due to ill-fortune. Agents who default are penalized to a degree proportional to the size of their default and to penalty parameters lambda. We find that under conditions similar to those necessary to guarantee the existence of GEI equilibrium, we get the existence of GEI λ equilibrium, for any λ > 0. We argue that default is thus reasonably modeled as an equilibrium phenomenon. Moreover, we show that more lenient lambda which encourage default may be Pareto improving because they allow for better risk spreading. When default occurs, the Modigliani-Miller theorem typically fails to hold in our framework.
Recommended Citation
Dubey, Pradeep; Geanakoplos, John; and Shubik, Martin, "Default and Efficiency in a General Equilibrium Model with Incomplete Markets" (1988). Cowles Foundation Discussion Papers. 1123.
https://elischolar.library.yale.edu/cowles-discussion-paper-series/1123