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Borrowing Constraint as an Optimal Contract

Author

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  • Grochulski, Borys
  • Zhang, Yuzhe

Abstract

We study a continuous-time version of the optimal risk-sharing problem with one-sided commitment. In the optimal contract, the agent's consumption is non-decreasing and depends only on the maximal level of the agent's income realized to date. In the complete-markets implementation of the optimal contract, the Alvarez-Jermann solvency constraints take the form of a simple borrowing constraint familiar from the Bewley-Aiyagari incomplete-markets models. Unlike in the incomplete-markets models, however, the asset buffer stock held by the agent is negatively correlated with income.

Suggested Citation

  • Grochulski, Borys & Zhang, Yuzhe, 2009. "Borrowing Constraint as an Optimal Contract," MPRA Paper 23216, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:23216
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    File URL: https://mpra.ub.uni-muenchen.de/23216/1/MPRA_paper_23216.pdf
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    References listed on IDEAS

    as
    1. Rui Albuquerque & Hugo A. Hopenhayn, 2004. "Optimal Lending Contracts and Firm Dynamics," Review of Economic Studies, Oxford University Press, vol. 71(2), pages 285-315.
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    More about this item

    Keywords

    Borrowing constraint; limited commitment;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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