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Collateral, Financial Arrangements and Pareto Optimality

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Author Info
Filippo Taddei

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Abstract

The existence of collateral requirements to guarantee repayment on issued securities reduces in general the efficiency of competitive equilibria. The general equilibrium analysis is presented in a world where reputation plays no role, and the lender always expects a future payment equal to the future market value of provided collateral. In this context I show that collateral requirements result in two distinct problems for efficiency. I argue that two financial arrangements, tranching and financial pyramiding, arise in developed capital markets in response to the challenges posed by collateral requirements. If these arrangements are sufficiently developed, then the pareto efficiency of competitive equilibria is restored, even in the presence of collateral requirements.

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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 64.

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Length: 21 pages
Date of creation: 2007
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Handle: RePEc:cca:wpaper:64

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Related research
Keywords: Collateral; Pareto Optimality; Financial Arrangements; Tranching; Financial Pyramiding.;

Find related papers by JEL classification:
D5 - Microeconomics - - General Equilibrium and Disequilibrium
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

This paper has been announced in the following NEP Reports:

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  1. John Geanakoplos & Michael Magill & Martine Quinzii & J. Dreze, 1988. "Generic Inefficiency of Stock Market Equilibrium When Markets Are Incomplete," Cowles Foundation Discussion Papers 863, Cowles Foundation, Yale University. [Downloadable!]
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  2. Atsushi Kajii & Antonio Villanacci & Alessandro Citanna, 1998. "Constrained suboptimality in incomplete markets: a general approach and two applications," Economic Theory, Springer, vol. 11(3), pages 495-521. [Downloadable!] (restricted)
  3. David Cass & Menahem E. Yaari, 1966. "A Re-examination of the Pure Consumption Loans Model," Journal of Political Economy, University of Chicago Press, vol. 74, pages 353. [Downloadable!] (restricted)
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This page was last updated on 2009-11-30.

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