Optimal Debt Contracts under Costly Enforcement

Hans Hvide and Tore Leite

No 6040, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behaviour in credit markets.

Keywords: Costly state verification; Debt contract; Priority violation; Strategic defaults (search for similar items in EconPapers)
JEL-codes: D02 D82 G21 G33 (search for similar items in EconPapers)
Date: 2007-01
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Citations: View citations in EconPapers (1)

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Journal Article: Optimal debt contracts under costly enforcement (2010)
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