Pooling and endogenous market incompleteness
Abstract
We study a financial market economy with a continuum of borrowers and pooling of borrowersrsquo promises. Under these conditions and in the absence of designing costs, utility-maximizing decisions of price-taking borrowers may lead to financial market incompleteness. Parametrizing equilibria through the borrowersrsquo no-arbitrage beliefs, we link expectations to the financial market structure. Markets are complete if and only if borrowersrsquo beliefs are homogeneous. Price-taking behavior causes a coordination problem which in turn yields indeterminacy and inefficiency of equilibrium allocations.