Borrowing Constraint as an Optimal Contract

Borys Grochulski and Yuzhe Zhang ()

MPRA Paper from University Library of Munich, Germany

Abstract: We study a continuous-time version of the optimal risk-sharing problem with one-sided commitment. In the optimal contract, the agent's consumption is non-decreasing and depends only on the maximal level of the agent's income realized to date. In the complete-markets implementation of the optimal contract, the Alvarez-Jermann solvency constraints take the form of a simple borrowing constraint familiar from the Bewley-Aiyagari incomplete-markets models. Unlike in the incomplete-markets models, however, the asset buffer stock held by the agent is negatively correlated with income.

Keywords: Borrowing constraint; limited commitment (search for similar items in EconPapers)
JEL-codes: D52 D86 (search for similar items in EconPapers)
Date: 2009
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