### Abstract

In this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S - I ≥ 2H - 1 [resp. S - I ≥ H + 1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.

Original language | English (US) |
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Pages (from-to) | 467-494 |

Number of pages | 28 |

Journal | Economic Theory |

Volume | 11 |

Issue number | 3 |

DOIs | |

State | Published - May 1998 |

### ASJC Scopus subject areas

- Economics and Econometrics

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## Cite this

*Economic Theory*,

*11*(3), 467-494. https://doi.org/10.1007/s001990050198