General Equilibrium with Endogenous Uncertainty and Default
37 Pages Posted: 7 Mar 2010
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General Equilibrium with Endogenous Uncertainty and Default
General Equilibrium with Endogenous Uncertainty and Default
Date Written: May 2006
Abstract
In this paper we study the introduction of new assets which are oftenly observed to be defined in expected values rather than state by state, called the Arrow-Lind-Malinvaud (ALM) assets. We demonstrate that individual default emerges naturally in an economy where such ALM assets are introduced without completing all contingency markets. We further provide conditions under which individual default is propagated endogenously into a collective risk of widespread default in general equilibrium.
Keywords: Default, financial innovation, individual risk, collective risk, endogenous uncertainty
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