### Abstract

In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S - I ≥ 2H - 1 [resp. S - I ≥ H + 1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.

Original language | English (US) |
---|---|

Pages (from-to) | 467-494 |

Number of pages | 28 |

Journal | Economic Theory |

Volume | 11 |

Issue number | 3 |

DOIs | |

State | Published - Jan 1 1998 |

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### ASJC Scopus subject areas

- Economics and Econometrics

### Cite this

*Economic Theory*,

*11*(3), 467-494. https://doi.org/10.1007/s001990050198

**Pareto improving financial innovation in incomplete markets.** / Cass, David; Citanna, Alessandro.

Research output: Contribution to journal › Article

*Economic Theory*, vol. 11, no. 3, pp. 467-494. https://doi.org/10.1007/s001990050198

}

TY - JOUR

T1 - Pareto improving financial innovation in incomplete markets

AU - Cass, David

AU - Citanna, Alessandro

PY - 1998/1/1

Y1 - 1998/1/1

N2 - In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S - I ≥ 2H - 1 [resp. S - I ≥ H + 1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.

AB - In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S - I ≥ 2H - 1 [resp. S - I ≥ H + 1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.

UR - http://www.scopus.com/inward/record.url?scp=0032219876&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=0032219876&partnerID=8YFLogxK

U2 - 10.1007/s001990050198

DO - 10.1007/s001990050198

M3 - Article

AN - SCOPUS:0032219876

VL - 11

SP - 467

EP - 494

JO - Economic Theory

JF - Economic Theory

SN - 0938-2259

IS - 3

ER -