Theoretical Economics 18 (2023), 1547–1583
Surprise and default in general equilibrium
I model an incomplete markets economy where unaware agents do not perceive all states of nature, so unintended default can occur when asset returns differ from what was perceived. The presence of default plays a crucial role in the proof of existence - particularly in economies where beliefs are biased - by removing perceived arbitrage opportunities with respect to delivery-adjusted asset returns. The First Fundamental Welfare Theorem fails because of default and pecuniary inefficiencies, but the Second Fundamental Welfare Theorem holds for economies with no aggregate risk. Welfare is shown to not necessarily be monotonic in discovery, or the increasing of awareness.
Keywords: General equilibrium, incomplete markets, default, unawareness
JEL classification: D52, D53, D83, G18
Full Text: PRINT VIEW