General equilibrium with endogenously incomplete financial markets

The present paper studies a class of general equilibrium economies with imperfectly competitive financial intermediaries and price-taking consumers. Intermediaries optimally choose the securities they issue and the bid-ask spread they charge. Financial intermediation is costly, and hence markets are endogenously incomplete. An appropriate equilibrium concept is developed, and existence is proved. Competitive equilibria for this class of economies display full indexation of securities payoffs and monetary neutrality even if intermediaries are restricted to issue "nominal" securities and financial markets turn out to be incomplete. This is in sharp contrast with the indeterminacy and non-neutrality results established in the literature for incomplete markets economies with exogenously given "nominal" securities. (C) 1998 Academic Press.