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With Additional Enforcement Mechanisms, does Collateral Avoid Ponzi Schemes?

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  • Thiago Revil
  • Juan Pablo Torres-Martínez

Abstract

In infinite horizon incomplete market economies, when the seizure of collateral guarantees is the only mechanism enforcing borrowers not to entirely default on their promises, equilibrium exists independently of the choice of collateral bundles.In these economies, we analyze if generic additional enforcement mechanisms besides the seizure of collateral guarantees may eliminate the existence of physical feasible individuals’ optimal plans. For this, we only need to focus on the decision problem of a price taker individual and on the effectiveness of the additional enforcement mechanisms, i.e. the amount of payments besides the value of collateral guarantees. Then, we show that there is a relationship between collateral requirements and the effectiveness of such additional mechanisms implying the non-existence of a solution for the individual’s problem.

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Bibliographic Info

Paper provided by University of Chile, Department of Economics in its series Working Papers with number wp278.

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Date of creation: May 2008
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Handle: RePEc:udc:wpaper:wp278

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Web page: http://www.econ.uchile.cl/
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Keywords: Effective default enforcements; Collateral guarantees; 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, 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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