Endogenous debt constraints in collateralized economies with default penalties

Victor Filipe Martins da Rocha () and Yiannis Vailakis ()
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Victor Filipe Martins da Rocha: CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
Yiannis Vailakis: University of Exeter Business School - University of Exeter
Authors registered in the RePEc Author Service: V. Filipe Martins-da-Rocha

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Abstract: The objective of the paper is to propose endogenous debt constraints that rule out Ponzi schemes and ensure the existence of equilibria in a model with limited commitment and (possible) default. We appropriately modify the definition of finitely effective debt constraints, introduced by Levine and Zame (1996) (see also Levine and Zame (2002)), to encompass models with limited commitment, default penalties and collateral. Along this line, we introduce in the setting of Araujo et al. (2002), Kubler and Schmedders (2003) and Páscoa and Seghir (2009) the concept of actions with finite equivalent payoffs. We show that, independent of the level of default penalties, restricting plans to have finite equivalent payoffs rules out Ponzi schemes and guarantees the existence of an equilibrium that is compatible with the minimal ability to borrow and lend that we expect in our model. An interesting feature of our debt constraints is that they give rise to budget sets that coincide with the standard budget sets of economies having a collateral structure but no penalties (as defined in Araujo et al. (2002)). This illustrates the hidden relation between finitely effective debt constraints and collateral requirements.

Keywords: Default; Debt constraints; Collateral; Ponzi schemes; Limited commitment; Incomplete markets; Infinite horizon economies (search for similar items in EconPapers)
Date: 2012-01
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Published in Journal of Mathematical Economics, 2012, 48 (1), pp.1-13. ⟨10.1016/j.jmateco.2011.09.006⟩

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Journal Article: Endogenous debt constraints in collateralized economies with default penalties (2012)
Working Paper: Endogenous debt constraints in collateralized economies with default penalties (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00664551

DOI: 10.1016/j.jmateco.2011.09.006

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