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Consumer Default with Complete Markets: Default-based Pricing and Finite Punishment

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This paper studies economies with complete markets where there is positive default on consumer debt. In a simple tractable two-period model, households can default partially, at a finite punishment cost, and competitive intermediaries price loans of different sizes separately. This environment yields only partial insurance. The default-based pricing of debt makes it too costly for the borrower to achieve full insurance and there is too little trade in securities. This framework is in contrast with existing literature. Unlike the literature with default, there are no restrictions on the set of state contingent securities that are issued. Unlike the literature on lack of commitment, limited trade arises without need of debt constraints that rule default out. Compared with the latter, the present approach appears to imply more consumption inequality. An extended model with an infinite horizon, idiosyncratic risk and more realistic assumptions is used to demonstrate the general validity of this approach and its main implications.

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  • Xavier Mateos-Planas & Giulio Seccia, 2013. "Consumer Default with Complete Markets: Default-based Pricing and Finite Punishment," Working Papers 711, Queen Mary University of London, School of Economics and Finance.
  • Handle: RePEc:qmw:qmwecw:wp711
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    References listed on IDEAS

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    Cited by:

    1. Florin Bidian & Camelia Bejan, 2015. "Martingale properties of self-enforcing debt," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(1), pages 35-57, September.

    More about this item

    Keywords

    Consumer default; Complete markets; Endogenous incomplete markets; Risk-based pricing; Risk sharing;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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