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With additional enforcement mechanisms,does Collateral avoid Ponzi Schemes ?

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  • Thiago Revil

    (Department of Economics, PUC-Rio)

  • Juan Pablo Torres-Martinez

    ()
    (Department of Economics, PUC-Rio)

Abstract

In infinite horizon incomplete market economies, Ponzi schemes are avoided and equilibrium exists when collateral repossession is the only mechanism enforcing borrowers not to entirely default on their promises. In these economies, we add default enforcement mechanisms that are effective, i.e. induce payments besides the value of collateral guarantees. We prove that, independently of prices, the individual’s problem does not have a physically feasible solution when collateral guarantees are not large enough relative to the effectiveness of the additional enforcement mechanisms. We also show that this result does not depend on specific types of such mechanisms, as long as they are effective.

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File URL: http://www.econ.puc-rio.br/pdf/td545_revisto_abril08.pdf
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Bibliographic Info

Paper provided by Department of Economics PUC-Rio (Brazil) in its series Textos para discussão with number 545.

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Length: 14p
Date of creation: Jul 2007
Date of revision: Apr 2008
Handle: RePEc:rio:texdis:545

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Keywords: Effective default enforcements; Collateral repossession; Individual’s optimality.;

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  1. Páscoa, Mário Rui & Seghir, Abdelkrim, 2009. "Harsh default penalties lead to Ponzi schemes," Games and Economic Behavior, Elsevier, Elsevier, vol. 65(1), pages 270-286, January.
  2. Steinert, Mariano & Torres-Martinez, Juan Pablo, 2007. "General equilibrium in CLO markets," Journal of Mathematical Economics, Elsevier, vol. 43(6), pages 709-734, August.
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