Debt collateralization, capital structure, and maximal leverage

Feixue Gong () and Gregory Phelan
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Feixue Gong: Massachusetts Institute of Technology

Economic Theory, 2020, vol. 70, issue 2, No 9, 579-605

Abstract: Abstract We study the effects of allowing risky debt to be used as collateral in a general equilibrium model with heterogeneous agents and collateralized financial contracts. With debt collateralization, investors switch to using exclusively high-leverage contracts for every investment they choose (issuing risky debt when possible). High-leverage positions maximize the ability of contracts to serve as collateral, expanding the set of state contingencies created from collateralized debt. We provide conditions under which debt collateralization will increase the price of the underlying asset. Our results also apply to variations in capital structure since many capital structures implicitly provide the ability to use debt contracts as collateral.

Keywords: Leverage; Incomplete markets; Asset prices; Default; Securitized markets; Asset-backed securities; Collateralized debt obligations (search for similar items in EconPapers)
JEL-codes: D52 D53 G11 G12 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Debt Collateralization, Capital Structure, and Maximal Leverage (2019)
Working Paper: Debt Collateralization, Capital Structure, and Maximal Leverage (2016)
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DOI: 10.1007/s00199-019-01222-7

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