Defaults and infinite prices in a stochastic pure exchange model

Abstract

A stochastic pure exchange model with perfect foresight is considered. Real indeterminacy arises in this setting in the form of continuum of equilibria corresponding to different commodity allocations. The cause of real indeterminacy is arbitrariness of prices at the final date. If some arbitrary price tends to infinity then the equilibrium in the limit has an intuitive economic interpretation. The limiting equilibrium with formally infinite prices we interpret as an equilibrium with default: if a special state of the environment occurs, consumers may forget about their debts and savings and start new life from scratch.Existence of equilibria with defaults is proven. A numerical experiment shows that in some cases equilibria with finite prices are Pareto dominated by equilibria with defaults.