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Endogenous credit limits with small default costs

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  • Costas Azariadis
  • Leo Kaas
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Abstract

We analyze an exchange economy of unsecured credit where borrowers have the option to declare bankruptcy in which case they are temporarily excluded from financial markets. Endogenous credit limits are imposed that are just tight enough to prevent default. Economies with temporary exclusion differ from their permanent exclusion counterparts in two important properties. If households are extremely patient, then the first–best allocation is an equilibrium in the latter economies but not necessarily in the former. In addition, temporary exclusion permits multiple stationary equilibria, with both complete and with incomplete consumption smoothing.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-048.

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Date of creation: 2012
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Handle: RePEc:fip:fedlwp:2012-048

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Keywords: Bankruptcy ; Credit;

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Cited by:
  1. Randall Wright & Chao Gu, 2011. "Endogenous Credit Cycles," 2011 Meeting Papers 373, Society for Economic Dynamics.
  2. Costas Azariadis & Leo Kaas, 2012. "Self-Fulfilling Credit Cycles," Working Paper Series of the Department of Economics, University of Konstanz 2012-16, Department of Economics, University of Konstanz.
  3. Bidian, Florin & Bejan, Camelia, 2011. "Martingale properties of self-enforcing debt," MPRA Paper 36609, University Library of Munich, Germany, revised 12 Feb 2012.
  4. Gaetano Bloise, 2013. "The structure of competitive equilibrium with unsecured debt," Departmental Working Papers of Economics - University 'Roma Tre' 0187, Department of Economics - University Roma Tre.

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