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Optimal debt contracts under costly enforcement

  • Hans Hvide

    ()

  • Tore Leite

    ()

We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behaviour in credit markets.

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File URL: http://hdl.handle.net/10.1007/s00199-009-0461-1
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Article provided by Springer in its journal Economic Theory.

Volume (Year): 44 (2010)
Issue (Month): 1 (July)
Pages: 149-165

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Handle: RePEc:spr:joecth:v:44:y:2010:i:1:p:149-165
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