Incomplete markets

The Theory of Incomplete Markets is an extension of the general equilibrium approach to intertemporal economies with uncertainty, where the set of available contracts which can be used to transfer wealth across time is limited relative to the possible probabilistic states that an economy might find itself in. Unlike in the standard Arrow-Debreu model where all trade is planned at beginning of time. These agents can do this for their descendents at the beginning of time in the Classical model (i.e. with complete markets) because agents are assumed to have costless contractual enforcement and perfect calculations along with perfect knowledge of the likelihood of all possible future states (across an unlimited range of contracts). In an economy with incomplete markets agents trade in sequential spot markets.

There are at least two results that significantly depart from those well-known results in complete markets.

#"Generic" Existence of Equilibrium
# Non Pareto-Optimality of Allocations

The First Welfare Theorem concerning the Pareto Optimality of general equilibrium no longer holds.

References

* Magill, Michael and Quinzii, Martine. (2002). "Theory of Incomplete Markets". MIT Press.