Endogenous debt constraints in collateralized economies with default penalties


Speaker:Yiannis Vailakis, Associate Professor in Economics
Date: Thursday 25 March 2010
Time: 16:15
Location: xfi L/T

Further details

One of the main difficulties of extending sequential markets economies to an infinite horizon is associated with the existence of the so-called Ponzi schemes. In the absence of a terminal date agents would attempt to finance unbounded levels of consumption by renewing their credit at infinite. If such schemes are permitted, the agent’s decision problem has no solution. Therefore, without debt constraints that limit the rate at which agents accumulate debt, equilibria fail to exist. This paper addresses the issue of Ponzi schemes in infinite horizon models with collateral and additional enforcement mechanisms. Ad hoc uniform bounds on borrowing or transversality type conditions that have been proposed in the literature are not satisfactory. The overall objective of the proposed research is to explore alternative debt constraints that are compatible with equilibrium (i.e. exclude Ponzi schemes) and simultaneously allow for as much risk sharing as possible. Our objective is to propose debt constraints that have the nice characteristic of being endogenous and finitely effective (that is, they enforce agents to repay their debts in finite time). Such constraints have been initially proposed by Levine and Zame (1996) but they have not attracted so far much attention.