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Market Based, Segregated Exchanges with Default Risk

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  • Kilenthong, Weerachart
  • Townsend, Robert

Abstract

This paper studies a competitive general equilibrium model with default and endogenous collateral constraints. Even though all collateralized contracts are allowed, the possibility and desirability of trade in spot markets (or the equivalent trade in ex ante asset backed securities) creates externalities, as spot prices (or security prices) and the bindingness of collateral constraints interact. We show that if agents are allowed to contract ex ante on market fundamentals determining the state-contingent spot price, over and above contracting on true underlying states of the world, then competitive equilibria with bundled securities and commodities and with endogenous collateral constraints are equivalent with Pareto optima. Examples show that it is possible to have multiple market fundamentals in equilibrium. Equivalently, it is possible for there to be segregation into distinct competitive securities exchanges with endogenous (positive and negative) entry fees. Fees accrue to borrowers who are otherwise collateral constrained.

Suggested Citation

  • Kilenthong, Weerachart & Townsend, Robert, 2007. "Market Based, Segregated Exchanges with Default Risk," MPRA Paper 20724, University Library of Munich, Germany, revised 12 Nov 2009.
    • Handle: RePEc:pra:mprapa:20724
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    References listed on IDEAS

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    Cited by:

    1. Weerachart Kilenthong & Robert Townsend, 2014. "Segregated Security Exchanges with Ex Ante Rights to Trade: A Market-Based Solution to Collateral-Constrained Externalities," NBER Working Papers 20086, National Bureau of Economic Research, Inc.
    2. Piero Gottardi & Felix Kubler, 2015. "Dynamic Competitive Economies with Complete Markets and Collateral Constraints," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(3), pages 1119-1153.
    3. Kilenthong, Weerachart T. & Townsend, Robert M., 2011. "Information-constrained optima with retrading: An externality and its market-based solution," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1042-1077, May.
    4. Weerachart Kilenthong, 2011. "Collateral premia and risk sharing under limited commitment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 46(3), pages 475-501, April.
    5. Dan Vu Cao, 2010. "Collateral Shortages, Asset Price And Investment Volatility With Heterogeneous Beliefs," 2010 Meeting Papers 1233, Society for Economic Dynamics.

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    More about this item

    Keywords

    default; endogenous collateral; externalities; segregated exchanges; Walrasian equilibrium; limited commitment; financial crises;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • G01 - Financial Economics - - General - - - Financial Crises

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