Book contents
- Frontmatter
- Contents
- List of Contributors
- Acknowledgments
- Introduction
- Part One General Equilibrium Theory
- Part Two Computational Methods
- Part Three Macroeconomics and Finance
- 5 Nonconvexities in Quantitative General Equilibrium Studies of Business Cycles
- 6 Lotteries for Consumers versus Lotteries for Firms
- 7 Default and Aggregate Fluctuations in Storage Economies
- 8 New Applications of General Equilibrium to Finance: Default and Collateral
- Part Four Public Finance, Development, and Climate Change
- Part Five General Equilibrium Restrictions and Estimation of Hedonic Models
- Part Six Policy Uses and Performance of AGE Models
- Index
8 - New Applications of General Equilibrium to Finance: Default and Collateral
Published online by Cambridge University Press: 14 January 2010
- Frontmatter
- Contents
- List of Contributors
- Acknowledgments
- Introduction
- Part One General Equilibrium Theory
- Part Two Computational Methods
- Part Three Macroeconomics and Finance
- 5 Nonconvexities in Quantitative General Equilibrium Studies of Business Cycles
- 6 Lotteries for Consumers versus Lotteries for Firms
- 7 Default and Aggregate Fluctuations in Storage Economies
- 8 New Applications of General Equilibrium to Finance: Default and Collateral
- Part Four Public Finance, Development, and Climate Change
- Part Five General Equilibrium Restrictions and Estimation of Hedonic Models
- Part Six Policy Uses and Performance of AGE Models
- Index
Summary
ABSTRACT: The applications of general equilibrium to finance can be grouped into three waves. The first started with the application of the Arrow–Debreu concept of state-contingent prices developed in the fifties to a better understanding of the Black–Scholes formula and the pricing of derivatives, in general. The second wave studied the abstract incomplete markets model in its several aspects: existence, determinacy, suboptimality, and infinite horizon properties. Market incompleteness was used to understand stochastic volatility of security prices and also to explain the risk premium puzzle. We can consider as a third wave the development of general equilibrium models with default to understand credit risk and institutional arrangements that can deal with it. This third wave was made possible by the incomplete markets theory and motivated by understanding how incompleteness can be mitigated by default or bankruptcy. More specifically, this chapter addresses in its second section the finite-horizon case, covering default and penalties, collateral, and consumers' bankruptcy. The third section deals with the infinite-horizon case, where Ponzi schemes may occur.
INTRODUCTION
The goal of this chapter is to study credit risk in the context of general equilibrium in incomplete markets. Default and bankruptcy are important real-life phenomena: firms, consumers, exchange houses, and governments fail to honor their commitments or go bankrupt. It is therefore important to incorporate these phenomena into equilibrium models as particular configurations of equilibrium outcomes.
- Type
- Chapter
- Information
- Frontiers in Applied General Equilibrium ModelingIn Honor of Herbert Scarf, pp. 151 - 172Publisher: Cambridge University PressPrint publication year: 2005