We investigate the welfare implications of alternative financial market structures in a two-country endowment economy model. We obtain an analytic expression for the expected lifetime utility of the representative household when sovereign bonds are the only internationally traded asset, and we compare this welfare level with that obtained under complete asset markets. The welfare cost of incomplete markets is negligible if agents are very patient and shocks are not very persistent, but this cost is dramatically larger if agents are relatively impatient and shocks are highly persistent. For realistic cases in which agents are very patient and shocks are highly persistent, the welfare cost of incomplete markets is highly sensitive to the specific values of these parameters.
Bibliographical noteFunding Information:
We appreciate comments and suggestions from two anonymous referees, Marianne Baxter, Hal Cole, Urban Jermann, Bob King, Robert Kollman, Stephanie Schmitt-Grohe, Chris Sims, Martin Uribe, Maria Vassalou, Eric van Wincoop, Paul Willen, and seminar participants at the Chicago Federal Reserve Bank, CEPR/LIFE/Weiss Center conference, Econometric Society World Congress, Federal Reserve Board, INSEAD, Korea Macro Workshop, Midwest Economic Association conference, Midwest Macroeconomics Conference, T2M conference, Johns Hopkins University, Tufts University, University of Pennsylvania, and the University of Virginia. J. Kim’s work on this project was supported by a Bankard grant from the University of Virginia.
- Incomplete markets
ASJC Scopus subject areas
- Economics and Econometrics