[1] In contrast with complete markets, this shortage of securities will likely restrict individuals from transferring the desired level of wealth among states.
If at each date-event there exists a complete set of such contracts, one for each contingency that can occur at the following date, individuals will trade these contracts in order to insure against future risks, targeting a desirable and budget feasible level of consumption in each state (i.e. consumption smoothing).
will lack the instruments to insure against future risks such as employment status, health, labor income, prices, among others.
In an "idealized" representation agents are assumed to have costless contractual enforcement and perfect knowledge of future states and their likelihood.
For example, if the economy lacks the institutions to guarantee that the contracts are enforced, it is unlikely that agents will either sell or buy these securities.
[4] In the economic and financial literature, a significant effort has been made in recent years to part from the setting of Complete Markets.
The other set of models explicitly account for the frictions that could prevent full insurance, but derive the optimal risk-sharing endogenously.
The advantage of this approach is that market incompleteness and the available state contingent claims respond to the economic environment, which makes the model appealing for policy experiments since it is less vulnerable to the Lucas critique.
In equilibrium, the two Arrow-Debreu securities have the same price and the allocation is as follows: The main outcome in this economy is that both Robinson and Jane will end up with 0.5 units of wealth independently of the state of nature that is realized.
The main point here is to illustrate the potential welfare losses that can arise if markets are incomplete.