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Is the regime of risk transfer sustainable? Impossible contract and inequality

Author

Listed:
  • Mirakhor, Abbas
  • Ng, Adam
  • Dewandaru, Ginanjar
  • Hamid, Baharom Abdul

Abstract

In a risk transfer and shifting financial systems, an interest rate based debt contract is an “impossible contract,” since, under the axioms of conventional economics, the borrower has an incentive not to repay the loan. Such impossible contract is made possible by creating a virtual world of certainty through mechanisms such as collateral requirements and an edifice of legal, administrative, policy incentive mechanisms that include positive and negative enforcements that protect the creditor. The society has to bear huge costs to make them possible. Risk sharing has the potential to enhance efficiency as each party to contracts has “skin-in-the-game”, thus eliminating or minimizing the principal-agent problem. Participants in a contract of an economic undertaking can choose higher risk-higher return projects thus increase the efficiency and productivity of the system. It can also create a reciprocal and trusting environment that strengthens social cohesion, promotes social mobility and reduces income inequality without perverse incentive effects.

Suggested Citation

  • Mirakhor, Abbas & Ng, Adam & Dewandaru, Ginanjar & Hamid, Baharom Abdul, 2017. "Is the regime of risk transfer sustainable? Impossible contract and inequality," Research in International Business and Finance, Elsevier, vol. 41(C), pages 16-19.
    • Handle: RePEc:eee:riibaf:v:41:y:2017:i:c:p:16-19
    DOI: 10.1016/j.ribaf.2017.04.001
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