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Segregated Security Exchanges with Ex Ante Rights to Trade: A Market-Based Solution to Collateral-Constrained Externalities

Author Info

Listed author(s):
  • Weerachart Kilenthong
  • Robert Townsend

Abstract

This paper studies a competitive general equilibrium model with default and endogenous collateralized contracts. The possibility of trade in spot markets creates externalities, as spot prices and the bindingness of collateral constraints interact. We propose a market based solution which overcomes the externalities problem and obviates the needs for any government policy intervention. If agents are allowed to contract ex ante on market fundamentals determining the state-contingent spot prices used to unwind collateral, over and above contracting on true underlying states of the world, then standard existence and welfare theorems apply, that is, competitive equilibria are equivalent with Pareto optima.

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File URL: http://www.nber.org/papers/w20086.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20086.

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Date of creation: May 2014
Handle: RePEc:nbr:nberwo:20086
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Find related papers by JEL classification:

  • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
  • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
  • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
  • D62 - Microeconomics - - Welfare Economics - - - Externalities

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Cited by:

  1. Ana Fostel & John Geanakoplos, 2013. "Financial Innovation, Collateral and Investment," Cowles Foundation Discussion Papers 1903R, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
  2. Grochulski, Borys, 2013. "Pecuniary Externalities, Segregated Exchanges, and Market Liquidity in a Diamond-Dybvig Economy with Retrade," Economic Quarterly, Federal Reserve Bank of Richmond, issue 4Q, pages 305-340.
  3. Eduardo Dávila & Anton Korinek, 2016. "Pecuniary Externalities in Economies with Financial Frictions," NBER Working Papers 22444, National Bureau of Economic Research, Inc.
  4. Ana Fostel & John Geanakoplos, 2016. "Financial Innovation, Collateral, and Investment," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 242-284, January.

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