nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒06‒18
twenty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Intergenerational complementarities in education, endogenous public policy, and the relation between growth and volatility By Palivos, Theodore; Varvarigos, Dimitrios
  2. Potential output in DSGE models By Igor Vetlov; Tibor Hlédik; Magnus Jonsson; Henrik Kucsera; Massimiliano Pisani
  3. Sectoral price facts in a sticky-price model By Carlos Carvalho; Jae Won Lee
  4. Labor wedges and open economy puzzles By Karabarbounis, Loukas
  5. Fractals and Self-Similarity in Economics: the Case of a Stochastic Two-Sector Growth Model By La Torre, Davide; Marsiglio, Simone; Privileggi, Fabio
  6. Ageing, Government Budgets, Retirement, and Growth By Dirk Niepelt; Martín Gonzalez-Eiras
  7. The Underground Economy in a Matching Model of Endogenous Growth By Lisi, Gaetano; Pugno, Maurizio
  8. Labor Market Search and Schooling Investment By Christopher Flinn
  9. Introducing Financial Assets into Structural Models By Jorge Fornero
  10. Revisiting the optimal population size problem under endogenous growth: minimal utility level and finite lives By Raouf Boucekkine; Giorgio Fabbri; Fausto Gozzi
  11. Vintage capital and the diffusion of clean technologies By Theophile Azomahou; Raouf Boucekkine; Phu Nguyen-Van
  12. Establishment heterogeneity, exporter dynamics, and the effects of trade liberalization By George Alessandria; Horag Choi
  13. Precautionary Savings and Wealth Inequality: a Global Sensitivity Analysis By Marco Cozzi
  14. Fiscal Adjustment to Shocks in Commodity-Producing Countries By Karlygash Kuralbayeva
  15. On a Unique Nondegenerate Distribution of Agents in the Huggett Model By Timothy Kam; Junsang Lee
  16. Fiscal Stimulus and Distortionary Taxation By Thorsten Drautzburg; Harald Uhlig
  17. Vintage capital theory: Three breakthroughs By Raouf Boucekkine; David De La Croix; Omar Licandro
  18. Chile’s Fiscal Rule as Social Insurance By Eduardo Engel; Christopher Neilson; Rodrigo Valdés
  19. Solving the Hotelling Model in Feedback Form By Sébastien ROUILLON (GREThA)
  20. Fiscal Multipliers and Policy Coordination By Gauti B. Eggertsson
  21. Career concerns : a human capital perspective By Camargos, Braz Ministério de; Pastorino, Elena
  22. Optimal Unemployment Insurance for Older Workers By Hairault, Jean-Olivier; Langot, François; Ménard, Sébastien; Sopraseuth, Thepthida
  23. Consumption Smoothing during Unemployment By Kolsrud, Jonas
  24. Financial Frictions and Credit Spreads By Ke Pang; Pierre L. Siklos
  25. Chris Pissarides, CEP's Nobel laureate By Barbara Petrongolo
  26. Core Concepts for Incomplete Market Economies By Helga Habis; P. Jean-Jacques Herings

  1. By: Palivos, Theodore; Varvarigos, Dimitrios
    Abstract: We construct an overlapping generations model in which parents vote on the tax rate that determines publicly provided education and offspring choose their effort in learning activities. The technology governing the accumulation of human capital allows these decisions to be strategic complements. In the presence of coordination failure, indeterminacy and, possibly, growth volatility emerge. This indeterminacy can be eliminated by an institutional mechanism that commits to a minimum level of public education provision. Given that, in the latter case, the economy moves along a uniquely determined balanced growth path, we argue that such structural differences can account for the negative correlation between volatility and growth.
    Keywords: Human Capital; Intergenerational Complementarities; Economic Growth; Endogenous Taxation; Volatility
    JEL: H42 O41 H52
    Date: 2011–04–16
  2. By: Igor Vetlov (Bank of Lithuania, Department of Economics, Economic Research Division, Gedimino pr. 6, LT-01103 Vilnius, Lithuania.); Tibor Hlédik (Czech National Bank.); Magnus Jonsson (Sveriges Riksbank.); Henrik Kucsera (Magyar Nemzeti Bank.); Massimiliano Pisani (Banca d’Italia.)
    Abstract: In view of the increasing use of Dynamic Stochastic General Equilibrium (DSGE) models in the macroeconomic projections and the policy process, this paper examines, both conceptually and empirically, alternative notions of potential output within DSGE models. Furthermore, it provides historical estimates of potential output/output gaps on the basis of selected DSGE models developed by the European System of Central Banks’ staff. These estimates are compared to the corresponding estimates obtained applying more traditional methods. Finally, the paper assesses the usefulness of the DSGE model-based output gaps for gauging inflationary pressures. JEL Classification: E32, E37, E52.
    Keywords: potential output, simulation and forecasting models, monetary policy.
    Date: 2011–06
  3. By: Carlos Carvalho; Jae Won Lee
    Abstract: We develop a multi-sector sticky-price DSGE (dynamic stochastic general equilibrium) model that can endogenously deliver differential responses of prices to aggregate and sectoral shocks. Input-output production linkages induce across-sector pricing complementarities that contribute to a slow response of prices to aggregate shocks. In turn, input-market segmentation at the sectoral level induces within-sector pricing substitutability, which helps the model deliver a fast response of prices to sector-specific shocks. Estimating the factor-augmented vector autoregression specification of Boivin, Giannoni, and Mihov (2009) on data generated by a parameterized version of our model, we find results that resemble what they obtain with disaggregated data for the U.S. economy. We then employ Bayesian methods to estimate the model using aggregate and sectoral data, and find that it accounts extremely well for a wide range of sectoral price facts.
    Date: 2011
  4. By: Karabarbounis, Loukas
    Abstract: A parsimonious model with home production, estimated to match moments of the “labor wedge,” explains prominent puzzles of the international business cycle. If market and home activity are substitutes, then the measured labor wedge increases whenever market consumption and employment decrease. Home production breaks the tight negative link between market consumption and its marginal utility and therefore helps explain the international risk sharing puzzle. In an estimated two-country dynamic general equilibrium model in which the labor wedge is endogenously generated to match its empirical moments, market output and market employment are more correlated than market consumption and investment across countries, relative market consumption is negatively related to the real exchange rate and real net exports are countercyclical. Further, the international risk sharing puzzle becomes easier to explain as the degree of financial completeness increases.
    Keywords: Labor Wedge; Home Production; International Business Cycles; Risk Sharing
    JEL: F4 F3 E3
    Date: 2010–10
  5. By: La Torre, Davide; Marsiglio, Simone; Privileggi, Fabio
    Abstract: We study a stochastic, discrete-time, two-sector optimal growth model in which the production of the homogeneous consumption good uses a Cobb-Douglas technology, combining physical capital and an endogenously determined share of human capital. Education is intensive in human capital as in Lucas (1988), but the marginal returns of the share of human capital employed in education are decreasing, as suggested by Rebelo (1991). Assuming that the exogenous shocks are i.i.d. and affect both physical and human capital, we build specific configurations for the primitives of the model so that the optimal dynamics for the state variables can be converted, through an appropriate log-transformation, into an Iterated Function System converging to an invariant distribution supported on a generalized Sierpinski gasket.
    Keywords: fractals, iterated function system, self-similarity, Sierpinski gasket, stochastic growth
    JEL: C61 O41
    Date: 2011–06
  6. By: Dirk Niepelt (Study Center Gerzensee, University of Bern, IIES Stockholm University); Martín Gonzalez-Eiras (Universidad de San Andrés)
    Abstract: We analyze the short and long run effects of demographic ageing—increased longevity and reduced fertility—on per-capita growth. The OLG model captures direct effects, working through adjustments in the savings rate, labor supply, and capital deepening, and indirect effects, working through changes of taxes, government spending components and the retirement age in politico-economic equilibrium. Growth is driven by capital accumulation and productivity increases fueled by public investment. The closed-form solutions of the model predict taxation and the retirement age in OECD economies to increase in response to demographic ageing and per-capita growth to accelerate. If the retirement age were held constant, the growth rate in politico-economic equilibrium would essentially remain unchanged, due to a surge of social security transfers and crowding out of public investment.
    Date: 2011–06
  7. By: Lisi, Gaetano; Pugno, Maurizio
    Abstract: A matching model will explain both unemployment and economic growth by considering the underground sector. Three problems can thus be simultaneously accounted for: (i) the persistence of underground economy, (ii) the ambiguous relationships between underground employment and unemployment, and (iii) between growth and unemployment. Key assumptions are that entrepreneurial ability is heterogeneous, skill accumulation determines productivity growth, job-seekers choose whether to invest in education. The conclusions are that the least able entrepreneurs set up underground firms, employ unskilled labour, and do not contribute to growth. Underground employment alleviates unemployment only if the monitoring rate is sufficiently low.
    Keywords: underground economy; entrepreneurship; growth; unemployment; matching models
    JEL: J6 J24 E26 L26
    Date: 2011–06–07
  8. By: Christopher Flinn
    Abstract: We generalize the standard search, matching, and bargaining framework to allow individuals to acquire productivity-enhancing schooling prior to labor market entry. As is well-known, search frictions and weakness in bargaining position contribute to under-investment from an efficiency perspective. In order to evaluate the sensitivity of schooling investments to "hold up," the model is estimated using Current Population Survey data. We focus on the impact of bargaining power on schooling investment, and find that the effects are large. A brief exploration of the two-sided investment model suggests that something akin to a "Hosios condition" result regarding the socially optimal surplus division rule may be attainable.
    Keywords: Labor market search; schooling choice; hold-up; Nash bargaining
    JEL: J24 J3 J64
    Date: 2011
  9. By: Jorge Fornero
    Abstract: This paper reviews extensively the literature on asset pricing and builds a structural dynamic general equilibrium model with financial assets. We obtain the policy function of the calibrated model and approximate it up to third order. We derive asset pricing and various premiums conditions up to the third order, meaning that returns depend on the first three conditional moments. We obtain a hypothetic yield curve whose curvature increases with the order of approximation because of premiums. In addition, impulse responses of various fundamental shocks illustrate the effects on the level and slope of bond yields with several maturities and on break-even inflation. Important shocks are technology and inflation target shocks.
    Date: 2011–05
  10. By: Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Giorgio Fabbri (Dipartimento Matematica e statistica - Université de Naples); Fausto Gozzi (Dipartimento di Scienze Economiche e Aziendali - Libera Università INTERNAZIONALE DEGLI STUDI SOCIALI G. CARLI)
    Abstract: In this paper, we devise a social criterion in the spirit of the critical utility level of Blackorby-Donaldson (1984) to study an optimal population size problem in an endogenously growing economy populated by workers living a fixed amount of time and without capital accumulation. Population growth is endogenous. The problem is analytically solved, yielding closed-form solutions to optimal demographic and economic dynamics. It is shown that provided the economy is not driven to optimal finite time extinction, the optimal solution is egalitarian for appropriate choices of the critical utility levels: all individuals of any cohort are given the same consumption. The results obtained do not require any priori restriction of the values of the elasticity of intertemporal substitution unlike in several related papers.
    Keywords: Optimal population size; finite life span; critical utility value; optimal extinction; balanced growth paths
    Date: 2011–06–08
  11. By: Theophile Azomahou (Maastricht University - univ. Maastricht); Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Phu Nguyen-Van (BETA - Bureau d'économie théorique et appliquée - CNRS : UMR7522 - Université de Strasbourg - Université Nancy II)
    Abstract: We develop a general equilibrium vintage capital model with energy-saving technological progress and an explicit energy sector to study the impact of investment subsidies on equilibrium investment and output. Energy and capital are assumed to be complementary in the production process. New machines are less energy consuming and scrapping is endogenous. Two polar market structures are considered for the energy market, free entry and natural monopoly. First, it is shown that investment subsidies may induce a larger equilibrium investment into cleaner technologies either under free entry or natural monopoly. However in the latter case, this happens if and only if the average cost is decreasing fast enough. Second, larger diffusion rates do not necessarily mean lower energy consumption at equilibrium, which may explain certain empirical observations.
    Keywords: Energy-saving technological progress; vintage capital; market imperfections; natural monopoly; investment
    Date: 2011–06–08
  12. By: George Alessandria; Horag Choi
    Abstract: The authors study the effects of tariffs in a dynamic variation of the Melitz (2003) model, a monopolistically competitive model with heterogeneity in productivity across establishments and fixed costs of exporting. With fixed costs of starting to export that are on average 3.7 times as large as the costs incurred to continue as an exporter, the model can match both the size distribution of exporters and annual transition in and out of exporting among US manufacturing establishments. The authors find that the tariff equivalent of these fixed costs is nearly 30 percentage points. They use the calibrated model to estimate the effect of reducing tariffs on welfare, trade, and export participation. The authors find sizeable gains to moving to free trade equivalent to 1.03 percent of steady state consumption. Considering the transition dynamics following the cut in tariffs, they find that the model predicts economic activity overshoots its steady state, with the peak in output coming 10 years after the trade reform. Because of this overshooting, steady state changes in consumption understate the welfare gain to trade reform. The authors also find simpler trade models that abstract from these export dynamics provide a poor approximation of the aggregate responses from our more general model.
    Keywords: International trade ; Tariff
    Date: 2011
  13. By: Marco Cozzi (Queen’s University)
    Abstract: This paper applies Canova JAE 1994 methodology to perform a thorough sensitivity analysis for the Aiyagari QJE 1994 economy. This is a calibrated GE model with incomplete markets and uninsurable income risk, designed to quantify the size of precautionary savings and the degree of wealth inequality. The results of this global robustness analysis are broadly consistent with Aiyagari’s findings. Even when considering priors for the parameters uncertainty which are highly dispersed, the size of the precautionary savings is modest: at most, they account for an 11% increase in the saving rate. However, the results show that the parameter representing the exogenous borrowing limit seems to lead to relatively large changes in measures of wealth inequality. The Gini index increases by 15 points when considering values of the borrowing limits that lead to empirically plausible shares of households with a negative net worth. The parameters that quantitatively have the largest effects on determining the wealth Gini index are the capital share, the borrowing limit, and the depreciation rate. The parameters affecting most significantly precautionary savings are the risk aversion and the standard deviation of the income shocks.
    Keywords: Precautionary Savings, Calibration, Heterogeneous Agents, Incomplete Markets, Computable General Equilibrium, Monte Carlo
    JEL: E21 D52 D58
    Date: 2011–06
  14. By: Karlygash Kuralbayeva
    Abstract: This paper investigates the optimal scal policy adjustment to adverse terms of trade shocks by commodity-producing countries within a general equilibrium model,which allows for explicit distinction between public investment and government consumption. As the private sector has limited room for maneuver in correcting the shock itself, the public sector is used to isolate the economy from external fluctuations. The ability of fiscal policy to shield the economy from external shocks critically depends on instruments available to government. In the presence of international capital market imperfections, the shock is absorbed primarily through a combination of reduced expenditure and higher taxes. Cuts in expenditure are carried out mostly through cuts in public investment, with the change in the levelof public investment being about ten times larger than the change in government consumption. Public investment is thus the main shock absorber in this situation and is highly pro-cyclical. In the absence of distortions on the international capital markets, government shifts from domestic sources to external sources to absorb the shock and resorts to increased external borrowing to finance the shortfall in revenues. In this case, responses of both public investment and government consumption are more smoothed and less pro-cyclical, whereas tax rate falls.
    Keywords: fiscal policy, adjustment, external shocks, commodity-producing countries
    JEL: E32 F41 H54
    Date: 2011
  15. By: Timothy Kam; Junsang Lee
    Abstract: The seminal work of Huggett [“The risk-free rate in heterogeneous-agent incomplete-insurance economies”, Journal of Economic Dynamics and Control, 1993, 17(5-6), 953-969] showed that there exists a unique stationary distribution of agent types, given by their individual states of asset and income endowment pairs. However, the question remains open if the equilibrium individual state space might turn out to be trivial, in the sense that every agent’s common borrowing constraint binds forever. If so, the invariant probability measure of agent types will place all mass on this minimal credit level. By invoking a simple comparative-static argument, we provide closure to this open question. We thus reinforce Huggett’s result of a unique stationary equilibrium distribution of agents by showing that it must also be one that is nontrivial or nondegenerate.
    JEL: C62 D31 D52
    Date: 2010–07
  16. By: Thorsten Drautzburg; Harald Uhlig
    Abstract: We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain, if they discount the future substantially.
    JEL: E62 E63 E65 H20 H62
    Date: 2011–06
  17. By: Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); David De La Croix (CORE - Department of Economics - Université Catholique de Louvain); Omar Licandro (IAE - Institut d'Anàlisi Econòmica - Universitat Autónoma de Barcelona)
    Abstract: Vintage capital growth models have been at the heart of growth theory in the 60s. This research line collapsed in the late 60s with the so-called embodiment controversy and the technical sophisitication of the vintage models. This paper analyzes the astonishing revival of this literature in the 90s. In particular, it outlines three methodological breakthroughs explaining this resurgence: a growth accounting revolution, taking advantage of the availability of new time series, an optimal control revolution allowing to safely study vintage capital optimal growth models, and a vintage human capital revolution, along with the rise of economic demography, accounting for the vintage structure of human capital similarly to physical capital age structuring. The related literature is surveyed.
    Keywords: Vintage capital; embodied technical progress; growth accounting; optimal control; endogenous growth; vintage human capital; demography.
    Date: 2011–06–08
  18. By: Eduardo Engel; Christopher Neilson; Rodrigo Valdés
    Abstract: We explore the role of fiscal policy over the business cycle from a normative perspective, for a government with a highly volatile and exogenous revenue source. Instead of resorting to Keynesian mechanisms, in our framework fiscal policy plays a role because the government provides transfers to heterogeneous households facing volatile income, albeit with an imperfect transfer technology (a fraction of transfers leak to richer households). We calibrate the model to Chile’s highly volatile government revenues derived from copper, and characterize the optimal fiscal reaction. We quantify the welfare gains vis-à-vis a balanced budget rule, and the degree of adequate fiscal countercyclicality. We also analyze simpler rules, such as the structural balance rule in place in Chile during the last decade, more general linear rules, and linear rules with an escape clause. We find that the optimal rule leads to the same welfare gain as doubling the government’s copper revenues under a balanced budget rule. Chile’s structural balance rule achieves 18% of these gains, while a linear rule with an escape clause achieves 83% of the gains. The degrees of countercyclicality of the optimal rule and the linear rule with an escape clause are similar, and much larger than those of the structural balance rule.
    Date: 2011–05
  19. By: Sébastien ROUILLON (GREThA)
    Abstract: We give a characterization, in feedback form, of the optimal extraction path of an exhaustible resource, which holds for a large class of models.
    Keywords: Hotelling rule; exhaustible resource; dynamic programming
    JEL: Q30 C61
    Date: 2011
  20. By: Gauti B. Eggertsson
    Abstract: This paper analyzes the effectiveness of fiscal policy at zero nominal interest rates. I solve a stochastic general equilibrium model with sticky prices assuming that the government cannot commit to future policy. Real government spending increases demand by boosting public consumption. Deficit spending increases demand by generating inflation expectations. I compute multipliers of government spending that calculate by how much each dollar of spending increases output. Both the deficit and the real spending multipliers can be large, but the multiplier of deficit spending depends critically on monetary and fiscal cooperation: it can be large with cooperation and zero without it. The theory suggests one interesting interpretation of why recovery measures–such as fiscal spending, exchange interventions, and large increases in the money supply–had a smaller effect on nominal demand in Japan during the Great Recession (1992-2006) than during the US's Great Depression (1929-1941). In both episodes, the short-term nominal interest rate was close to zero. The theory suggests that part of the difference can be explained by the fact that, while monetary and fiscal policy were coordinated in the US during the Great Depression, they were not in Japan during the Great Recession. The overall conclusion of the paper is that the effect of given policy actions depends crucially on the institutional setup in the economy.
    Date: 2011–05
  21. By: Camargos, Braz Ministério de; Pastorino, Elena
    Abstract: We introduce human capital accumulation, in the form of learning{by{doing, in alife cycle model of career concerns and analyze how human capital acquisition a ectsimplicit incentives for performance. We show that standard results from the careerconcerns literature can be reversed in the presence of human capital accumulation.Namely, implicit incentives need not decrease over time and may decrease with thedegree of uncertainty about an individual's talent. Furthermore, increasing the pre-cision of output measurement can weaken rather than strengthen implicit incentives.Overall, our results contribute to shed new light on the ability of markets to disciplinemoral hazard in the absence of explicit contracts linking pay to performance.
    Date: 2011–06–02
  22. By: Hairault, Jean-Olivier; Langot, François; Ménard, Sébastien; Sopraseuth, Thepthida
    Abstract: This paper shows that optimal unemployment insurance contracts are age-dependent. Older workers have only a few years left on the labor market prior to retirement. This short horizon implies a more decreasing replacement ratio. However, there is a sufficiently short distance to retirement for which flat unemployment benefits can be the optimal contract. It is the result of the inability to reconcile both incentives and insurance for the soon-to-be-retired unemployed workers. We show that the unemployment benefit agency could take advantage of the retirement period to tax pensions in order to optimize the trade-off between insurance and incentives at the end of working life.
    Keywords: Unemployment insurance; Retirement; Recursive contracts; Moral Hazard
    JEL: C61 J64 J65
    Date: 2011–06
  23. By: Kolsrud, Jonas (Uppsala Center for Labor Studies)
    Abstract: A vast literature has investigated how unemployment insurance (UI) affects labor supply. However, the distorting effect of UI on labor supply is to a large extent determined by how well UI benefits smooth private consumption, which in turn depends on the resources available to the unemployed. To determine UI’s consumption-smoothing effect, I exploit a kink in the deterministic relationship between previous earnings and unemployment benefits. The randomized assignment of benefits created by the kink allows me to identify how UI affect the use of private wealth to finance consumption during unemployment spells. Using Swedish data for 2000 - 2002 I find that a large share of the unemployed actually can consume at the same level as they did prior to the layoff. I also find that loans are of great importance to consumption smoothing as more than half the sample lacks buffer savings. This is further emphasized for different subpopulations. Women, couples, and older individuals holds significantly larger liquid wealth than men and young singles.
    Keywords: Saving; wealth; unemployment benefit; unemployment; consumption smoothing
    JEL: D91 J64 J65
    Date: 2011–06–03
  24. By: Ke Pang; Pierre L. Siklos
    Abstract: This paper uses the credit-friction model developed by Curdia and Woodford, in a series of papers, as the basis for attempting to mimic the behavior of credit spreads in moderate as well as crisis times. We are able to generate movements in representative credit spreads that are, at times, both sharp and volatile. We then study the impact of quantitative easing and credit easing. Credit easing is found to reduce spreads, unlike quantitative easing, which has opposite effects. The relative advantage of credit easing becomes even clearer when we allow borrowers to default on their loans. Since increases in default offset the beneficial effects of credit easing on spreads, the policy implication is that, in times of financial stress, the central bank should be aggressive when applying credit easing policies.
    Keywords: Credit easing, credit spread, financial friction, quantitative easing.
    JEL: E43 E44 E51 E58
    Date: 2010–12
  25. By: Barbara Petrongolo
    Abstract: Barbara Petrongolo outlines how his analysis of markets with search frictions has enhanced our understanding of how labour markets work and how policy-makers should respond
    Date: 2011–03
  26. By: Helga Habis (Institute of Economics - Hungarian Academy of Sciences); P. Jean-Jacques Herings (Department of Economics, Universiteit Maastricht)
    Abstract: We examine the notion of the core when cooperation takes place in a setting with time and uncertainty. We do so in a two-period general equilibrium setting with incomplete markets. Market incompleteness implies that players cannot make all possible binding commitments regarding their actions at different date-events. We unify various treatments of dynamic core concepts existing in the literature. This results in definitions of the Classical Core, the Segregated Core, the Two-stage Core, the Strong Sequential Core, and the Weak Sequential Core. Except for the Classical Core, all these concepts can be defined by requiring absence of blocking in period 0 and at any date-event in period 1. The concepts only differ with respect to the notion of blocking in period 0. To evaluate these concepts, we study three market structures in detail: strongly complete markets, incomplete markets in finance economies, and incomplete markets in settings with multiple commodities. Even when markets are strongly complete, the Classical Core is argued not to be an appropriate concept. For the general case of incomplete markets, the Weak Sequential Core is the only concept that does not suffer from major defects.
    Keywords: Incomplete Markets, Dynamic Core Concepts, Time and uncertainty
    JEL: C71 C73 D52
    Date: 2011–05

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