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Collateralized debt as the optimal contract

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  • Jeffrey M. Lacker

Abstract

In a simple risk-sharing environment with ex post private information, conditions are found under which a collateralized debt contract is the optimal allocation. The critical condition for optimality is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. I argue that perhaps all debt contracts are implicitly collateralized.

Suggested Citation

  • Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:98-04
    Note: Also published as 90-3R2
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    References listed on IDEAS

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    More about this item

    Keywords

    Debt;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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