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Collateralized Debt as the Optimal Contract

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  • Jeffrey Lacker

    (Federal Reserve Bank of Richmond)

Abstract

In a multiple-good risk-sharing environment with ex post private information, conditions are found under which collateralized debt is the optimal contract. The necessary and sufficient condition is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1006/redy.2001.0138
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 4 (2001)
Issue (Month): 4 (October)
Pages: 842-859

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Handle: RePEc:red:issued:v:4:y:2001:i:4:p:842-859

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Keywords: debt; financial contracts; optimal contracts; collateral; asymmetric information; borrowing constraints;

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References

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  1. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
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  13. Jeffrey M. Lacker, 1989. "Limited commitment and costly enforcement," Working Paper 90-02, Federal Reserve Bank of Richmond.
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  16. Benjamin, Daniel K, 1978. "The Use of Collateral to Enforce Debt Contracts," Economic Inquiry, Western Economic Association International, vol. 16(3), pages 333-59, July.
  17. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, vol. 67(4), pages 539-61, October.
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