Liquidity and Bankruptcy with Incomplete Markets: Pure Exchange
We enlarge the standard model of general equilibrium with incomplete market (GEI), to incorporate liquidity constraints as well as the possibility of bankruptcy and default. A new equilibrium results, which we abbreviate GELBI (general equilibrium with liquidity, bankruptcy and incomplete markets). When the supply of bank money and bankruptcy/default penalties are taken suﬀiciently high (the high regime), GEI occur as GELBI. But outside the high regime many new phenomena appear: money is (almost) never neutral, it has positive value and its optimum quantity is often ﬁnite; bankruptcy and default not only occur in equilibrium but can have welfare improving consequences for everyone; there is no real indeterminacy even with ﬁnancial assets.
Dubey, Pradeep and Geanakoplos, John, "Liquidity and Bankruptcy with Incomplete Markets: Pure Exchange" (1989). Cowles Foundation Discussion Papers. 1144.