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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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    File URL: http://www.econ.qmul.ac.uk/papers/doc/wp711.pdf
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    Paper provided by Queen Mary University of London, School of Economics and Finance in its series Working Papers with number 711.

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    Date of creation: Nov 2013
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    Handle: RePEc:qmw:qmwecw:wp711
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    8. Andolfatto, David & Gervais, Martin, 2008. "Endogenous debt constraints in a life-cycle model with an application to social security," Journal of Economic Dynamics and Control, Elsevier, vol. 32(12), pages 3745-3759, December.
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    13. Cordoba, Juan-Carlos, 2008. "U.S. inequality: Debt constraints or incomplete asset markets?," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 350-364, March.
    14. Javier Díaz-Giménez & Andrew Glover & José-Víctor Ríos-Rull, 2011. "Facts on the distributions of earnings, income, and wealth in the United States: 2007 update," Quarterly Review, Federal Reserve Bank of Minneapolis.
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    17. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2002. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) 2, Centro de Altisimos Estudios Rios Perez (CAERP).
    18. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2008. "The Macroeconomic Implications of Rising Wage Inequality in the United States," NBER Working Papers 14052, National Bureau of Economic Research, Inc.
    19. Xavier Mateos-Planas & David Benjamin, 2012. "Formal vs. Informal Default in Consumer Credit," 2012 Meeting Papers 144, Society for Economic Dynamics.
    20. Mateos-Planas, Xavier, 2013. "Credit limits and bankruptcy," Economics Letters, Elsevier, vol. 121(3), pages 469-472.
    21. Rubén Poblete-Cazenave & Juan Torres-Martínez, 2013. "Equilibrium with limited-recourse collateralized loans," Economic Theory, Springer, vol. 53(1), pages 181-211, May.
    22. Weerachart Kilenthong, 2011. "Collateral premia and risk sharing under limited commitment," Economic Theory, Springer, vol. 46(3), pages 475-501, April.
    23. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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    25. Mateos-Planas, Xavier & Seccia, Giulio, 2006. "Welfare implications of endogenous credit limits with bankruptcy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2081-2115, November.
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