Research Database

This paper considers the unobserved endowment economy of Green (1987) with a restriction that agents can walk away from insurance contracts at the beginning of any period and contract with another insurer (one-sided commitment). An equilibrium is derived characterized by a unique, market determined insurance contract with the property that agents never want to walk away from it. I show that trade (or insurance) still occurs and that a non-degenerate long-ran distribution of consumption exists.

A cash-in-advance model with sequential markets is constructed, where unanticipated monetary injections are nonneutral and can potentially produce large liquidity effects. However, if the monetary authority adheres to an optimal money rule, money should not respond to unanticipated shocks, so that a Friedman rule is suboptimal and the monetary authority does not exploit the liquidity effect. Quantitatively, the model can generate variability in money and nominal interest rates close to what is observed, and can produce data with no obvious evidence of the existence of liquidity effects.

We formulate a representative consumer model of intertemporal resource reallocation in which fluctuations in equity prices contribute to the smoothing of consumption flows. Features of the model include (a) an incompletely observable stochastic process of productivity shocks leading to fluctuating confidence of beliefs and (b) technologies involving commitments of a resource good. These features are exploited to show that (1) equities are not a representative form of total wealth and (2) the valuation of currently active firms is not representative of the valuation of all firms. We examine the implications of (1) and (2) to argue that empirical findings for the volatility and 'value shortfall' of equity prices may be consistent with a frictionless representative consumer model having a low degree of risk-aversion. Simulation of a calibrated version of the model for a risk-neutral consumer shows that when the 'data' is analyzed according to current econometric procedures, it is found to exhibit volatility of the same order of magnitude as that found in the actual data, although the model contains no excess volatility.