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Endogenous debt constraints in collateralized economies with default penalties

  • Martins-da-Rocha, V. Filipe
  • Vailakis, Yiannis

The objective of the paper is to propose endogenous debt constraints that rule out Ponzi schemes and ensure the existence of equilibria in a model with limited commitment and (possible) default. We appropriately modify the definition of finitely effective debt constraints, introduced by Levine and Zame (1996) (see also Levine and Zame (2002)), to encompass models with limited commitment, default penalties and collateral. Along this line, we introduce in the setting of Araujo et al. (2002), Kubler and Schmedders (2003) and Páscoa and Seghir (2009) the concept of actions with finite equivalent payoffs. We show that, independent of the level of default penalties, restricting plans to have finite equivalent payoffs rules out Ponzi schemes and guarantees the existence of an equilibrium that is compatible with the minimal ability to borrow and lend that we expect in our model.

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Article provided by Elsevier in its journal Journal of Mathematical Economics.

Volume (Year): 48 (2012)
Issue (Month): 1 ()
Pages: 1-13

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Handle: RePEc:eee:mateco:v:48:y:2012:i:1:p:1-13
Contact details of provider: Web page: http://www.elsevier.com/locate/jmateco

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  28. 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.
  29. Martins-da-Rocha, V. Filipe & Vailakis, Yiannis, 2012. "Harsh default penalties lead to Ponzi schemes: A counterexample," Games and Economic Behavior, Elsevier, vol. 75(1), pages 277-282.
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