Debt Contract, Strategic Default, and Optimal Penalties with Judgement Errors
AbstractWe characterize the competitive equilibrium on the credit market when borrowers can strategically default. We assume that the audit is subject of errors of the two types and that lenders cannot commit ex-ante. We determine the penalty, the loan rate, the audit and strategic default probabilities. Borrowers' limited liability is endogenous when "judicial errors" exist, strategic default appears at equilibrium depending on the borrowers' absolute risk aversion. We show that at equilibrium loan contracts exhibit a penalty such that borrowers never strategically default. This is true with IARA and CARA utility function. Finally, we show that with DARA, strategic default may exist.
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Bibliographic InfoArticle provided by Society for AEF in its journal Annals of Economics and Finance.
Volume (Year): 5 (2004)
Issue (Month): 2 (November)
Strategic default; Imperfect audit; Fine; Consumer credit;
Other versions of this item:
- Gollier, Christian & Alary, David, 2004. "Debt Contract, Strategic Default, and Optimal Penalties with Judgement Errors," Economics Papers from University Paris Dauphine 123456789/6457, Paris Dauphine University.
- D18 - Microeconomics - - Household Behavior - - - Consumer Protection
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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