Inefficiency of competitive equilibrium with hidden action and financial markets

Abstract

In this paper, we study a pure exchange economy with idiosyncratic uncertainty, hidden action and multiple consumption goods. We consider two different market structures : contingent markets on the one hand, and financial and spot markets on the other hand. We propose a competitive equilibrium concept for each market structure. We show that the equilibrium with contingent markets is efficient in an appropriate sense, while the equilibrium with financial and spot markets is inefficient, provided that assumptions on preferences more general than those usually considered in the literature hold.Hidden action, enforcement, constrained efficiency