General equilibrium with endogenous uncertainty and default

Graciela Chichilnisky
Columbia University, United States

Ho-Mou Wu
College of Management, University of Taiwan and China Center for Economic Research (CCER),
Peking University, China

Available online 2 August 2006

Abstract
We study the introduction of new assets that are defined in expected values rather than state by state. Individual default emerges naturally in an economy where such 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. We prove existence of a general equilibrium with endogenous uncertainty.

© 2006 Elsevier B.V. All rights reserved.

Keywords: Default; Financial innovation; Individual risk; Collective risk; Endogenous uncertainty

Journal of Mathematical Economics 42 (2006) 499–524  download 2010050421093.pdf