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The impossibility of effective enforcement mechanisms in collateralized credit markets

Thiago Revil T. Ferreira and Juan Pablo Torres-Martinez ()

MPRA Paper from University Library of Munich, Germany

Abstract: We analyze the possibility of the simultaneous presence of three key features in price-taking credit markets: infinity horizon, collateralized credit operations and effective additional enforcement mechanisms, i.e. those implying payments besides the value of the collateral guarantees. We show that these additional mechanisms, instead of strengthening, actually weaken the restrictions that collateral places on borrowing. In fact, when collateral requirements are not large enough in relation to the effectiveness of the additional mechanisms, lenders anticipate total payments exceeding the value of the collateral requirements. Thus, by non-arbitrage, they lend more than the value of these guarantees. In turn, in the absence of other market frictions such as borrowing constraints, agents may indefinitely postpone their debts, implying the collapse of the agent's maximization problem and of such credit markets.

Keywords: Effective default enforcements; Collateral guarantees; Individual's optimality (search for similar items in EconPapers)
JEL-codes: D52 D53 (search for similar items in EconPapers)
Date: 2009-03
New Economics Papers: this item is included in nep-rmg
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https://mpra.ub.uni-muenchen.de/13781/1/MPRA_paper_13781.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/18294/1/MPRA_paper_18294.pdf revised version (application/pdf)

Related works:
Journal Article: The impossibility of effective enforcement mechanisms in collateralized credit markets (2010) Downloads
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