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Optimal debt contracts under costly enforcement

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  • Hans Hvide

    ()

  • Tore Leite

    ()

Abstract

We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behaviour in credit markets.

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File URL: http://hdl.handle.net/10.1007/s00199-009-0461-1
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 44 (2010)
Issue (Month): 1 (July)
Pages: 149-165

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Handle: RePEc:spr:joecth:v:44:y:2010:i:1:p:149-165

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Related research

Keywords: Costly state verification; Debt contract; Priority violation; Strategic defaults; D02; D82; G21; G3;

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  1. Bester, Helmut & Strausz, Roland, 2001. "Contracting with Imperfect Commitment and the Revelation Principle: The Single Agent Case," Econometrica, Econometric Society, vol. 69(4), pages 1077-98, July.
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  12. Winton, Andrew, 1995. "Costly State Verification and Multiple Investors: The Role of Seniority," Review of Financial Studies, Society for Financial Studies, vol. 8(1), pages 91-123.
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  15. David Martimort & Lars Stole, 2001. "Common Agency Equilibria with Discrete Mechanisms and Discrete Types," CESifo Working Paper Series 572, CESifo Group Munich.
  16. Renou, Ludovic & Carlier, Guillaume, 2006. "Debt contracts with ex-ante and ex-post asymmetric information: an example," Economics Papers from University Paris Dauphine 123456789/7447, Paris Dauphine University.
  17. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  18. Guillaume Carlier & Ludovic Renou, 2005. "A costly state verification model with diversity of opinions," Economic Theory, Springer, vol. 25(2), pages 497-504, 02.
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