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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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Related research

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

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References

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  1. Lacker, J.M., 1989. "Optimal Contracts Under Costly State Falsification," Purdue University Economics Working Papers 956, Purdue University, Department of Economics.
  2. Arrow, Kenneth J, 1974. "Limited Knowledge and Economic Analysis," American Economic Review, American Economic Association, vol. 64(1), pages 1-10, March.
  3. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Timothy Curry & Joseph Blalock & Rebel Cole, 1991. "Recoveries on Distressed Real Estate and The Relative Efficiency of Public versus Private Management," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 19(4), pages 495-515.
  5. Stephen D. Williamson, 1984. "Costly Monitoring, Loan Contracts and Equilibrium Credit Rationing," Working Papers 572, Queen's University, Department of Economics.
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  8. Barro, Robert J, 1976. "The Loan Market, Collateral, and Rates of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(4), pages 439-56, November.
  9. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  10. 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.
  11. 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.
  12. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  13. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
  14. Harris Milton & Townsend, Robert M, 1981. "Resource Allocation under Asymmetric Information," Econometrica, Econometric Society, vol. 49(1), pages 33-64, January.
  15. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  16. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  17. Cheng Wang & Stephen D. Williamson, 1998. "Debt Contracts with Financial Intermediation with Costly Screening," Canadian Journal of Economics, Canadian Economics Association, vol. 31(3), pages 573-595, August.
  18. Jeffrey M. Lacker, 1989. "Limited commitment and costly enforcement," Working Paper 90-02, Federal Reserve Bank of Richmond.
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