Survival, arbitrage, and equilibrium with financial derivatives in constrained asset markets

• Published in: Seoul journal of economics Vol. 25; no. 4; pp. 441 - 461
• Main Authors: Hahn, Guangsug, Won, Dong Chul
• Format: Journal Article
• Language: English
• Published: Seoul Univ 01.01.2012; Institute of Economic Research; 경제연구소
• Subjects: Arbitrage; Assets; Derivatives; Economic models; Equilibrium; Market economies; Studies; 경제학
• ISSN: 1225-0279

Survival conditions ensure the presence of consumptions that cost less than the total contingent income of agents in general equilibrium models. These conditions are generally fulfilled in competitive equilibrium. This paper shows the existence of equilibrium for incomplete-market economies where individuals' asset holdings are subject to portfolio constraints by introducing a new survival condition. Based on McKenzie's irreducibllity assumption, Gottardi and Hens (1996) provide the GEI irreducibllity condition for the existence of equilibrium in unconstrained asset markets. The GEI irreducibility condition, however, leaves no room for redundant assets such as financial derivatives simply because they do not contribute to the creation of risk-sharing opportunities in unconstrained asset markets. Thus, such condition is no longer valid in constrained asset markets where re- dundant assets are empowered to affect the financial ability of agents to possess 'cheaper' consumptions in equilibrium. This paper extends the irreducibility assumption of Gottardi and Hens (1996) to constrained asset markets by considering the capability of financial derivatives to create intertemporal income transfers.