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Default and Punishment in General Equilibrium 1
Author(s) -
Dubey Pradeep,
Geanakoplos John,
Shubik Martin
Publication year - 2005
Publication title -
econometrica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 16.7
H-Index - 199
eISSN - 1468-0262
pISSN - 0012-9682
DOI - 10.1111/j.1468-0262.2005.00563.x
Subject(s) - economics , general equilibrium theory , loan , adverse selection , irrational number , competition (biology) , punishment (psychology) , competitive equilibrium , order (exchange) , default , microeconomics , econometrics , mathematical economics , finance , mathematics , psychology , social psychology , ecology , geometry , biology
We extend the standard model of general equilibrium with incomplete markets to allow for default and punishment by thinking of assets as pools. The equilibrating variables include expected delivery rates, along with the usual prices of assets and commodities. By reinterpreting the variables, our model encompasses a broad range of adverse selection and signalling phenomena in a perfectly competitive, general equilibrium framework. Perfect competition eliminates the need for lenders to compute how the size of their loan or the price they quote might affect default rates. It also makes for a simple equilibrium refinement, which we propose in order to rule out irrational pessimism about deliveries of untraded assets. We show that refined equilibrium always exists in our model, and that default, in conjunction with refinement, opens the door to a theory of endogenous assets. The market chooses the promises, default penalties, and quantity constraints of actively traded assets.