Incomplete Financial Markets With Real Assets and Endogenous Credit Limits

In this paper we analyze the effects of restricted participation in a two-period general equilibrium model with uncertainty in the second period and real assets. Similar to certain arrangements in the market for bank loans, household borrowing is restricted by a ousehold-specific wealth dependent upper bound on credit lines in all states of uncertainty in the second period. We first establish that, generically in the set of the economies, equilibria exist and are finite and regular. We then show that equilibria are generically suboptimal. Finally, we provide a robust example demonstrating that the equilibrium allocations can be Pareto improved through a tightening of the participation constraints.