Chapter 17.

Incomplete Markets Models

In the complete markets model of chapter 8, the optimal
consumption allocation is not history dependent: the allocation depends
on the current value of the Markov state variable only. This outcome
reects the comprehensive opportunities to insure risks that markets
provide. This chapter and chapter 19 describe settings with more
impediments to exchanging risks. These reduced opportunities make
allocations his- tory dependent. In this chapter, the history dependence
is encoded in the dependence of a households consumption on the
households current asset holdings. In chapter 19, history dependence is
encoded in the dependence of the consumption allocation on a
continuation value promised by a planner or principal.
The present chapter describes a particular type of incomplete
markets model. The models have a large number of ex ante identical but
ex post heterogeneous agents who trade a single security. For most of
this chapter, we study models with no aggregate uncertainty and no
variation of an aggregate state variable over time (so macroeconomic
time series variation is absent). But there is much uncertainty at the
individual level. Households only option is to self-insure
by
managing a stock of a single asset to buer their consumption against
adverse shocks. We study several models that dier mainly with
respect to the particular asset that is the vehicle for
self-insurance, for example, at currency or capital.
The tools for constructing these models are discrete-state discounted
dynamic programmingused to formulate and solve problems of the
individuals; and Markov chainsused to compute a stationary wealth
distribution. The models produce a sta- tionary wealth distribution that is
determined simultaneously with various aggregates that are dened as
means across corresponding individual-level variables.
We begin by recalling our discrete state formulation of a single-agent
innite horizon savings problem. We then describe several economies in
which households face some version of this innite horizon saving
problem, and where some of the

528

A savings problem

529

prices taken parametrically in each households problem are determined by the

average
behavior of all households.1
This class of models was invented by Bewley (1977, 1980, 1983,
1986) partly to study a set of classic issues in monetary theory. The
second half of this chapter joins that enterprise by using the model to
represent inside and outside money, a free banking regime, a subtle limit
to the scope of Friedmans optimal quantity of money,
a model of
international exchange rate indeterminacy, and some related issues. The
chapter closes by describing some recent work of Krusell and Smith
(1998) designed to extend the domain of such models to include a timevarying stochastic aggregate state variable. As we shall see, this
innovation makes the state of the households problem include the timet cross-section distribution of wealth, an immense object.
Researchers have used calibrated versions of Bewley models to give
quantitative answers to questions including the welfare costs of ination
(I mrohoroglu, 1992), the risk-sharing benets of unfunded social
security systems (I mrohoroglu, I mrohoroglu,
and Joines, 1995), the benets of insuring unemployed people (Hansen and
I mrohoroglu, 1992), and the welfare costs of taxing capital (Aiyagari,
1995).

17.1. A savings problem

Recall the discrete state saving problem described in chapters 4 and
16. The house- holds labor income at time t, st , evolves according to
an m-state Markov chain with
transition matrix P . If the realization of the process at t is si , then at
time t the
household receives labor income wsi . Thus, employment opportunities
determine the labor income process. We shall sometimes assume that
m is 2, and that st takes the value 0 in an unemployed state and 1 in
an employed state.
We constrain holdings of a single asset to a grid A = [0 < a1 < a2
< ... < an]. For given values of ( w, r ) and given initial values ( a0, s0 ) the
household chooses a

1 Most of the heterogeneous agent models in this chapter have been arranged
to
shut down aggregate variations over time, to avoid the curse of
dimensionality that comes into play in formulating the households
dynamic programming problem when there is an aggregate state
variable. But we also describe a model of Krusell and Smith (1998)
that has an aggregate state variable.

530
Models

Chapter 17: Incomplete Markets

policy for {at+1}t=0 to maximize

E0

tu(ct),

(17.2.1)

t=0

subject
to

(17.2.2)
ct + at+1 = (1 + r)at
+ wst at+1 A

where (0, 1) is a discount factor;

concave,

u(c) is a strictly increasing, strictly

twice continuously dierentiable

one-period utility function satisfying the
Inada con- dition limc0 u(c) = + ; and
(1 + r) < 1.
2
The Bellman equation, for each i [ 1, ... , m] and each h [1,... , n], is
m

v(ah , si ) = max{u[(1 + r)ah + wsi a ] +

arA

P (i, j)v(a, sj )}, (17.2.3)

j=1

where a is next periods value of asset holdings. Here v(s) a, is the

optimal value of the objective function, starting from assetemployment state ( a, s). Note that the
grid A incorporates upper and lower limits on the quantity that can be
borrowed (i.e., the amount of the asset that can be issued). The upper
bound on A is restrictive.
In
some of our theortical discussion to follow, it will be important to
dispense with that upper bound.
In chapter 16, we described how to solve equation ( 17.2.3 ) for a value
function
v(a, s) and an associated policy function a = g(a, s) mapping this
periods ( a, s) pair into an optimal choice of assets to carry into next
period.

2 The Inada condition makes consumption nonnegative, and this fact plays a
role
in justifying the natural debt limit below.

A savings problem

17.2.1.

531

Wealth-employment distributions
Dene
the
unconditional
distribution of (at, st) pairs, t(a, s) = Prob(at
=
a, st =
s). The
exogenous
policy
function
a = g(a, s) Markov chain P on s and the optimal
induce a law of motion for the distribution t , namely,
Prob(st+1 = s, at+1 = a) =

..

Prob(at+1 = a|at = a, st = s)

a t st

Prob(st+1 = s |st = s) Prob(at = a, st = s),

or
t+1 (a, s) =

..
a

t (a, s)Prob(st+1 = s|st = s) I (a , s, a),

where we dene the

indicator function I(a, a, s) = 1 if a = g(a, s),
and 0 other- wise. 3 The indicator function
I(a , a, s) = 1 identies the
time- t states a, s that are sent into a at time t + 1 . The preceding
equation can be expressed as
.

t+1 (a, s) =
.

t (a, s)P (s, s).

(17.2.4)

{a:ar=g(a,s)}
s

A time-invariant distribution that solves equation ( 17.2.4 ) (i.e., one

for which t+1 = t ) is called a stationary distribution. One way to
compute a stationary distribution is to iterate to convergence on
equation ( 17.2.4 ). An alternative is to create a Markov chain that
describes the solution of the optimum problem, then to compute an
invariant distribution from a left eigenvector associated with a unit
eigenvalue of the stochastic matrix (see chapter 2).
To deduce this Markov chain, we map the pair ( a, s) of vectors
into a single-state vector x as follows. For i = 1 , . . . , n , h = 1 , . . . , m ,
let the j th element of x be the
pair ( ai , sh ), where j = (i1)m+h. Thus, we denote x = [(a1, s1 ), (a1 , s2 ), . . . , (a1, sm),
(a2 , s1), . . . ,
(a2, sm),..., (an, s1),..., (an, sm)] . The optimal policy function a = g(a, s) and
the Markov chain P on s induce a Markov chain on xt via the formula
Prob[(at+1 = a, st+1 = s)|(at = a, st = s)]
= Prob(at+1 = a|at = a, st = s) Prob(st+1 = s|st = s)
= I (a , a, s)P (s, s),
3 This construction exploits the fact that the optimal policy is a
deterministic function of the state, which comes from the concavity of
the objective function and the convexity of the constraint set.

532

Chapter 17: Incomplete Markets Models

where I (a , a, s) = 1 is dened as above. This formula denes an N

N matrix P , where N = n4 m. This is the Markov chain on the
households state vector x.
Suppose that the Markov chain associated with P is asymptotically
stationary and has a unique invariant distribution . Typically, all
states in the Markov chain
will be recurrent, and the individual will occasionally revisit each state. For
long
samples, the distribution tells the fraction of time that the
household spends in each state. We can unstack the state vector x
and use to deduce the stationary probability measure (ai, sh) over (
a, s) pairs, where
(ai, sh) = Prob(at = ai, st = sh) = (j),
and where (j) is the j th component of the vector , and j = (i 1)m + h
.

17.2.2.

Reinterpretation of the distribution

The solution of the households optimum saving problem induces a
stationary dis- tribution (a, s) that tells the fraction of time that an
innitely lived agent spends in state (a, s). We want to reinterpret (a,
s). Thus, let (a, s) index the state of a particular household at a
particular time period t, and assume that there is a proba- bility
distribution of households over state (a, s). We start the economy at
time t = 0 with a distribution (a, s) of households that we want to
repeat itself over time. The models in this chapter arrange the initial
distribution and other things so that the distribution of agents over
individual state variables (a, s) remains constant over time even
though the state of the individual household is a stochastic process.
We shall study several models of this type.

4 Various Matlab programs to be described later in this chapter create the

Markov
chain for the joint (a, s) state.

A savings problem

17.2.3.

533

Example 1: A pure credit model

Mark Huggett (1993) studied a pure exchange economy. Each of a
continuum of households has access to a centralized loan market in
which it can borrow or lend at a constant net risk-free interest rate of
r . Each households endowment is governed by
the Markov chain (P , s) . The household can either borrow or lend at a
constant riskfree rate. However, total borrowings cannot exceed > 0, where is a
parameter set by Huggett. A households setting of next
periods
level of assets is restricted to the
discrete set A = [a1,..., am] , where the lower bound on assets a1 = . Later
well
discuss alternative ways to set
, and how it relates to a natural borrowing
limit.
The solution of the households problem is a policy function a = g(a,
s) that induces a stationary distribution (a, s) over states. Huggett uses
the following de- nition:

Definicin: Dado , un equilibrio estacionario con una tasa de

inters r , una funcin de poltica g(a, s), y una distribucin
estacionaria (a, s) por cual:
a. La funcin poltica g(a, s) resuelve ptimamente el problema de los hogares
b. La distribucin estacionaria (a, s) es inducida por (P , s) y g(a, s).
c. El Mercado de prstamos seala
.
(a, s)g(a, s) = 0.
a,s

17.2.4.

Clculo del equilibrio

Huggett calcula el equilibrio utilizando un algoritmo iterativo. Se ja
una r = rj para j = 0 , por eso r resuelve el problema de los hogares
para una poltica de funcin gj(a, s) y esta asociada a una distribucin
estacionaria j(a, s). Luego se comprueba para ver si el mercado
de prstamos se libera a rj calculando
.
j(a, s)g(a, s) = je.
a,s

e >
j

Si
0 , Huggett plantea rj+1 anterior rj y se recalcula el exceso de
demanda, continuando estas iteraciones hasta que encontrar una R
en la que el exceso de demanda de crdito sea cero.

534

17.2.5.

Captulo 17: Modelo de mercados incompletos

Ejemplo 2: Un modelo con capital

El siguiente modelo fue creado por Rao Aiyagari (1994). El utilize una
version del problema del ahorro en una economa con muchos
agentes, interpretando el nico activo como el capital fsico
homognea, denotado por k . Las participaciones en el capital de un
hogar evolucionan segn
kt+1 = (1 )kt + xt
Donde (0, 1) es una tasa devaluada y xt es la inversin bruta. el
consumo de los hogares se ve limitada por
ct + xt = rkt + wst ,
Donde r es la tasa de arrendamiento del capital y w es un salario
competitivo, que se determinar ms adelante. Las dos ecuaciones
anteriores se pueden combinan para convertirse en:
ct + kt+1 = (1 + r )kt + wst ,
De acuerdo a la ecuacin ( 17.2.2 ) si se toma at kt y r r .
Hay un gran nmero de hogares con preferencias idnticas ( 17.2.1)
cuya distribucin (k, s) de pares esta dada por (k, s), y cuyo
comportamiento promedio determina (w, r) como sigue: Los hogares son
idnticos en sus preferencias, los procesos de Markov se rigen por sus
oportunidades de empleo, y los precios que se enfrentan.
t
Sin embargo dieren en sus
De oportunidades de empleo
0 = {sh}
t
historias s
h=0
y por lo tanto en el capital que se ha acumulado.
Cada familia tiene su propia
trayectoria

st asi como
su propio capital inicial k0 . Los procesos de productividad se
0
supone que son independientes entre los hogares. El comportamiento de las
trayectorias de estos hogares determina los salaries y la tasa de inters ( w, r ).
Se asume una distribucin inicial entre los hogares de (k, s). El
nivel promedio de capital K por hogar satisce
.
K=
(k, s)g(k, s),
k,s

Donde k = g(k, s). Asumiendo que se parti de la distribucin

invariante, el nivel promedio de empleo es
N = s,

Donde es la distribucin invariante asociada con P y s es la forma exgena especica

de para cada tasa de empleo individual. La tasa media de empleo es exgeno al modelo,
pero el nivel medio de capital es endgeno

A savings problem

535

Hay una funcin de produccin agregada cuyos argumentos son los

niveles medios de la capital y el empleo. La funcin de produccin
determina las tasa de inters en el capital y el trabajo segn
las
condiciones marginales
w = F (K, N
)/N r = F
(K, N )/K
Donde F (K, N ) = AKN 1 y (0, 1).
Ahora tenemos identicado todos los elementos
cuales un equilibrio estacionario se dene.

en trminos de los

Definicin de equilibrio: Un equilibrio estacionario es

una poltica de funcin g(k, s), una distribucin de probabilidad(k,
s), y los nmeros reales positivos ( K, r, w ) de tal manera que:
a. Los precios ( w, r ) satisfacen
w = F (K, N )/N

(17.2.5)

r = F (K, N )/K
.

b. La poltica de funcin
hogares

resuelve de manera ptima el problema de los

g(k, s)

c. La probabilidad de la distribucin (k, s) es una distribucin

estacionaria asociada con [g(k, s), P ]; esto es,si satisface
.
.
(k, s)P (s, s).
(k , s) =
s

{k:kr =g(k,s)}

d. El valor medio de K est determinada por el promedio de las decisiones de

los hogares
K=

.
k,s

(k, s)g(k, s).

536
Models

17.2.6.

Chapter 17: Incomplete Markets

Clculo del equilibrio

Aiyagari calcular un equilibrio del modelo donde K IR
Dentro IR , con la propiedad de que un punto de la asignacin ja sea
un equilibrio K . Aqu se tiene un algoritmo para hallar un punto jo:
1. Para un valor jo de K = Kj con j = 0 , calcule ( w, r ) de la
ecuacin ( 17.2.5 ), a continucacin resuelva de forma ptima el
problema de los hogares. Use la poltica ptima gj(k, s) para
deducir el equilibrio asociado a la distribucin j (k, s).
2. Calcular el valor medio de capital asociado a j (k, s), a saber,

Kj =

j (k, s)gj(k, s).

k,s

3. Para jar el parmetro de relajacin (0, 1), calcular una nueva estimacin
de K de mtodo5
Kj+1 = Kj + (1 )Kj .
4. Iterar en este esquema para la convergencia.
Luego,vamos a mostrar algunos ejemplos de equilibrio realizado con
el modelo Huggetts y el modelo de Aiyagaris . Pero primero vamos
analizar algunas de las caractersticas de ambos modelos de manera
ms formal.

5 By setting < 1 , the relaxation method often converges to a xed point in

cases
in which direct iteration (i.e., setting = 0 ) fails to
converge.

Digression: the nonstochastic savings problem

537

17.3. Unicacin y su anlisis posterior

Podemos mostrar caractersticas ms destacadas de varios modelos
mediante el uso de los grcos de Aiyagari (1994). Vamos a mostrar las
relaciones entre varios modelos que tienen idnticos los sectores
domsticos pero tienen diferentes suposiciones sobre el nico activo que
comercializan.Para simplicar recordadr el problema bsico del ahorro.El
objetivo de las familias para maximizar es

.
E0
tu(ct)
(17.3.1a)
t=0

ct + at+1 = wst + (1 + r)at

(17.3.1b) sujeto a la restriccin de crdito:
at+1 .

(17.3.1c)

Ahora suponemos que temporalmente at+1 puede tomar cualquier

valor real superior . Por lo tanto ,se supone que ahora at [,
+). De vez en cuando
encontramos que es til representar
1+ el factor de descuento (0, 1) en

trminos de una

tasa de descuento como =

. E n l a e c u a c i n (17.3.1b ),w es
1
aveces una funcin dada (r) de la tasa de inters neta de r.

17.4. Digresin: el problema del ahorro no estocstico

Es recommendable estudiar la version estocstica del problema del
ahorro cuando (1 + r) < 1. Para (1 + r) = 1 , se studio este
problema en el captulo 16. Para obtener el problema de ahorro no
estocstico, se assume que st en algn nivel positive s.Asociado al
problema de maximizacin de las familias esta la funcin de
Lagrange
Donde {t} es una secuencia no negativa de los multiplicadores de Lagrange en
la restricin
t=0
Presupuestaria.Su condicin de primer orden es:

L=

t {u(ct) + t [(1 + r)at + ws ct at+1]} ,

(17.4.1)

t=0

u(ct ) (1 + r)u (ct+1 ), = Si at+1 > .

(17.4.2)
Parat+1 > , la condicin de primer orden implica:
1
u(ct+1 ) =

(1 + r)

u(ct ),

(17.4.3)

538

Chapter 17: Incomplete Markets Models

Debido a que (1 + r) < 1 sucesivamente implica que u(ct+1) > u(ct )

y ct+1 < ct . Por lo tanto el consumo disminuye en los peridos
cuando los hogares no piden prstamos de forma limitada. Por lo
tanto, {ct} es una secuencia montona decreciente. Si esto se limita
,ya sea por la condicin de Inada u() a 0 o una restriccin no
negative en ct , entonces ct converger a t + . Entonces
cuando converge , las familias estarn endeudas de manera
limitada.
Podemos calcular el nivel constante de consumo cuando el hogar se
queda atrapado permanentemente en una restriccin para tener obtener
un crdito. La serie at+1 = at = . Esta relacin y ( 17.3.1b ) nos da:
ct = c = ws r.
(17.4.4)
Esto es el ingreso laboral luego de pagar el inters neto de mi deuda. A
las familias les gustara cambiar su consume de hoy para maana pero
no puede
Si resolvemos la restriccin presupuestaria future obtenemos una
restriccin presupuestaria al valor presente.

.
1
a0 = (1 + r)
(1 + r)t (ct ws).
(17.4.5)
t=0

As ,cuando (1 + r) < 1 , el consumes planeado de las familias se

puede obtener a partir de la resolucin de las siguientes ecuaciones (
17.4.5 ), ( 17.4.4 ), y ( 17.4.3) para un perido incial c0 y tiempo T
despus que el lmite de la deuda se vincula a ct que es una
constant.
Se require que el consume sea no negativo, 6 la ecuacin ( 17.4.4 ) nos dice que el
lmite de la deuda debe satisfacer
ws

.
(17.4.6)
r

Traemos a la derecha el lmite de la deuda rsi < ws , decimos que hay un

lmite de deuda ad hoc.

Hemos deducido que (1 + r) < 1 , siempre y cuando exista un

nivel de estado estacionario, el consume se da por la ecuacin (
17.4.4 ) y los activos como at = .
Ahora volviendo al caso en que (1 + r ) = 1 . La ecuacin (
17.4.3 ) implica que ct+1 = ct y a que la restriccin presupuestaria
sea ct = ws + ra y at+1 = at = a0 . Cuando (1 + r) = 1 , algn a0 ser
el valor estacionario de a . Es ptimo tener siempre una cantidad
de active incial.
6 Consumption must be nonnegative, for example, if we impose the
Inada condition discussed earlier.

Borrowing limits: natural and ad hoc

539

En resumen en el caso que determina el estado estacionario para la demanda

de activos es

cuando (1 + r) < 1 (i.e.,cuando r < ); y es igual a

a0 cuando r = . El nivel de estado estacionario es a , entonces se tiene

a = . , if r < ;
a0, if r = ,
Donde = (1 + )1 . Cuando r = , decimos que el estado
estacionario del nivel de activos a es indeterminado.

17.5. Lmites de endeudamiento: natural y ad hoc

Volvemos al caso estocsticos y nos ocuparemos de los factores de los
lmites de endeudamiento. Se considera que ct 0 implica el sugimiento
de que Aiyagari llame natural a un lmite de deuda.
Entonces
implica que
ct 0 y resolviendo la ecuacin ( 17.3.1b )
1
.
wst+j (1 + r)j.
at
1 + r j=0

(17.5.1)

Por el lado derecho es una variable aleatoria, no conocido para t, se

complementa a la ecuacin ( 17.5.1 ) para obtener la restriccin de
crdito. Un posible enfoque es sustituir el lado derecho de la
ecuacin ( 17.5.1 ) con una condicn con expectativas que se
requiere jar a la ecuacin ( 17.5.1 ) para obtener un valor esperado.
Pero esta formulacin del valor esperado es incompatible con la
nocin de que el prstamo est libre de riesgo, y que la familia
puede paga con seguridad. Si decimos que la ecuacin ( 17.5.1 ) se
mantiene ja en todo momento.
t 0 , a continuacin, se obtiene la restriccin que se obtiene al
reemplazar con min s s1 ,cuyos rendimientos
s1w
a
.
(17.5.2)

t
r
Aiyagari (1994) llama a esto el "lmite de la deuda natural". To
accommodate possibly more stringent debt limits, beyond those dictated
by the notion that it is feasible to repay the debt for sure, Aiyagari
species the debt limit as
at ,
wher
e

=
min.

s1 w

.,
r
and b > 0 is an arbitrary parameter dening an ad hoc debt
b,

(17.5.3)
(17.5.4)
limit.

540

17.5.1.

Chapter 17: Incomplete Markets Models

A candidate for a single state variable

For the special case in which s is i.i.d., Aiyagari showed how to cast
the model in terms of a single state variable to appear in the
households value function. To synthesize a single state variable, note
that the disposable resources available to be allocated at t are zt =
wst + (1+ r)at + . Thus, zt is the sum of the current endowment,
current savings at the beginning of the period, and the maximimal
borrowing capacity . This can be rewritten as
zt = wst + (1 + r)at r
where at at + . In terms of the single state variable zt , the
households budget set can be represented recursively as
ct + at+1 zt

(17.5.5a)

zt+1 = wst+1 + (1 + r)at+1 r

(17.5.5b)

where we must have at+1 0 . The Bellman equation

is
v(zt, st) = max

at+1 0 {u(zt

at+1) + Ev(zt+1 , st+1)} .

(17.5.6)

Here st appears in the state vector purely as an information variable

for predicting the employment component st+1 of next periods
disposable resources zt+1 , conditional on the choice of at+1 made
this period. Therefore, it disappears from both the value function and
the decision rule in the i.i.d. case.
More generally, with a serially correlated state, associated with the
solution of the Bellman equation is a policy function
at+1 = A(zt , st ).

(17.5.7)

Borrowing limits: natural and ad hoc

17.5.2.

541

Supermartingale convergence again

Lets revisit a main issue from chapter 16, but now consider the possible case
(1+r) <
1 . From equation ( 17.5.5a ), optimal consumption satises ct = zt A(zt, st).
The
optimal policy obeys the Euler inequality:
u(ct ) (1 + r)Et u(ct+1 ), = if at+1 > 0.

(17.5.8)

We can use equation ( 17.5.8 ) to deduce signicant aspects of the

limiting behavior of mean assets as a function of r . Following
Chamberlain and Wilson (2000) and others, to deduce the eect of r
on the mean of assets, we analyze the limiting behavior of
consumption implied by the Euler inequality ( 17.5.8 ). Dene
Mt = t (1 + r)t u(ct ) 0.
Then Mt+1 Mt = t(1 + r)t[(1 + r)u(ct+1) u(ct)] .
17.5.8) can be written
Et(Mt+1 Mt) 0,

Equation (
(17.5.9)

which asserts that Mt is a supermartingale. Because Mt is nonnegative, the

supermartingale convergence theorem applies. It asserts
that Mt converges
almost surely to a nonnegative random variable M : Mt a.s. M .
It is interesting to consider three cases: (1) (1 + r) > 1; (2) (1 + r) < 1,
and
(3)
(1 + r) = 1 . In case 1, the fact that M converges implies that
u(ct ) converges to zero almost surely. If u() tis unbounded (has no
satiation point), this fact then implies that ct + and that the
consumers asset holdings must be diverging to
+ . Chamberlain and Wilson (2000) show that such results also characterize
the
borderline case (3) (see chapter 16).
In case 2, convergence of Mt leaves
open the
possibility that u(c) does not converge a.s., that it remains nite
and continues to vary randomly. Indeed, when (1 + r) < 1 , the
average level of assets remains nite, and so does the level of
consumption.
It is easier to analyze the borderline case (1 + r) = 1 in the
special case that the employment process is independently and
identically distributed, meaning that
the stochastic matrix P has identical rows. 7 In this case, st provides no
information
about zt+1 , and so st can be dropped as an argument of both v() and A(). For
the
case in which st is i. i. d., Aiyagari (1994) uses the following argument by
contradiction
7 See chapter 16 for a closely related proof.