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Market Based, Segregated Exchanges with Default Risk

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  • Kilenthong, Weerachart
  • Townsend, Robert

Abstract

This paper studies a competitive general equilibrium model with default and endogenous collateral constraints. Even though all collateralized contracts are allowed, the possibility and desirability of trade in spot markets (or the equivalent trade in ex ante asset backed securities) creates externalities, as spot prices (or security prices) and the bindingness of collateral constraints interact. We show that if agents are allowed to contract ex ante on market fundamentals determining the state-contingent spot price, over and above contracting on true underlying states of the world, then competitive equilibria with bundled securities and commodities and with endogenous collateral constraints are equivalent with Pareto optima. Examples show that it is possible to have multiple market fundamentals in equilibrium. Equivalently, it is possible for there to be segregation into distinct competitive securities exchanges with endogenous (positive and negative) entry fees. Fees accrue to borrowers who are otherwise collateral constrained.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20724.

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Date of creation: 01 Nov 2007
Date of revision: 12 Nov 2009
Handle: RePEc:pra:mprapa:20724

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Related research

Keywords: default; endogenous collateral; externalities; segregated exchanges; Walrasian equilibrium; limited commitment; financial crises;

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References

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Citations

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Cited by:
  1. Weerachart Kilenthong, 2011. "Collateral premia and risk sharing under limited commitment," Economic Theory, Springer, Springer, vol. 46(3), pages 475-501, April.
  2. Felix Kubler & Piero Gottardi, 2012. "Dynamic Competitive Economies with Complete Markets and Collateral Constraints," 2012 Meeting Papers, Society for Economic Dynamics 467, Society for Economic Dynamics.
  3. Dan Cao, 2011. "Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs," Working Papers, Georgetown University, Department of Economics gueconwpa~11-11-01, Georgetown University, Department of Economics.
  4. Weerachart Kilenthong & Robert Townsend, 2014. "Segregated Security Exchanges with Ex Ante Rights to Trade: A Market-Based Solution to Collateral-Constrained Externalities," NBER Working Papers 20086, National Bureau of Economic Research, Inc.

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