Computing equilibria in finance economies with incomplete markets and transaction costs

P.J.J. Herings*, K Schmedders

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

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Abstract

Transaction costs on financial markets may have important consequences for volumes of trade, asset pricing, and welfare. This paper introduces an algorithm for the computation of equilibria in the general equilibrium model with incomplete asset markets and transaction costs. We show that economies with transaction costs can be analyzed with differentiable homotopy techniques and thus in the same framework as frictionless economies despite the existence of non-differentiabilities of agents' asset demand functions and the existence of locally non-unique equilibria. We introduce an equilibrium selection concept into the computation of economic equilibria that picks out a specific equilibrium in the presence of a continuum of equilibria.

Original languageEnglish
Pages (from-to)493-512
Number of pages20
JournalEconomic Theory
Volume27
Issue number3
DOIs
Publication statusPublished - Apr 2006
Externally publishedYes

Keywords

  • transaction costs
  • incomplete markets
  • computational methods
  • asset pricing
  • ASSET MARKETS
  • GENERAL EQUILIBRIUM
  • RELOCALIZATION
  • MODEL
  • TAX

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