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A dynamic model of unsecured credit

  • Daniel R. Sanches
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    The author studies the terms of credit in a competitive market in which sellers (lenders) are willing to repeatedly finance the purchases of buyers (borrowers) by engaging in a credit relationship. The key frictions are: (i) the lender is unable to observe the borrower's ability to repay a loan; (ii) the borrower cannot commit to any long-term contract; (iii) it is costly for the lender to contact a borrower and to walk away from a contract; and (iv) transactions within each credit relationship are not publicly observable. The lender's optimal contract has two key properties: delayed settlement and debt forgiveness. Asymmetric information gives rise to the property of delayed settlement, which is a contingency in which the lender allows the borrower to defer the repayment of his loan in exchange for more favorable terms of credit within the relationship. This property, together with the borrowers' lack of commitment, gives rise to debt forgiveness. When the borrower's participation constraint binds, the lender needs to "forgive" part of the borrower's debt to keep him in the relationship. Finally, the author studies the impact of the changes in the initial cost of lending on the terms of credit.

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    File URL: http://www.philadelphiafed.org/research-and-data/publications/working-papers/2011/wp11-2.pdf
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    Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-2.

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    Date of creation: 2010
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    Handle: RePEc:fip:fedpwp:11-2
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    1. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
    2. Aiyagari, S. Rao & Williamson, Stephen D., 2000. "Money and Dynamic Credit Arrangements with Private Information," Journal of Economic Theory, Elsevier, vol. 91(2), pages 248-279, April.
    3. Livshits, Igor & MacGee, James & Tertilt, Michèle, 2011. "Costly Contracts and Consumer Credit," CEPR Discussion Papers 8580, C.E.P.R. Discussion Papers.
    4. Satyajit Chatterjee & Dean Corbae & José-Víctor Ríos-Rull, 2007. "A finite-life private-information theory of unsecured consumer debt," Working Papers 07-14, Federal Reserve Bank of Philadelphia.
    5. David Andolfatto, 2011. "The simple analytics of money and credit in a quasi-linear environment," Working Papers 2011-038, Federal Reserve Bank of St. Louis.
    6. Irina A. Telyukova & Randall Wright, 2006. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," 2006 Meeting Papers 45, Society for Economic Dynamics.
    7. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
    8. Aiyagari, S.R. & Williamson, S.D., 1997. "Credit in a Random Matching Model with Private Information," Working Papers 97-03, University of Iowa, Department of Economics.
    9. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 209-44, January.
    10. Temzelides, Ted & Williamson, Stephen D., 2001. "Payments Systems Design in Deterministic and Private Information Environments," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 297-326, July.
    11. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
    12. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
    13. Nosal, Ed & Rocheteau, Guillaume, 2011. "Money, Payments, and Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262016281, June.
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