Debt Limits and Credit Bubbles in General Equilibrium

48 Pages Posted: 22 Oct 2019

See all articles by V. Filipe Martins-da-Rocha

V. Filipe Martins-da-Rocha

Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics

Toan Phan

Federal Reserve Banks - Federal Reserve Bank of Richmond

Yiannis Vailakis

University of Glasgow

Date Written: October 2, 2019

Abstract

We provide a novel characterization of self-enforcing debt limits in a general equilibrium framework of risk sharing with limited commitment, where defaulters are subject to recourse (a fractional loss of current and future endowments) and exclusion from future credit. We show that debt limits are exactly equal to the present value of recourse plus a credit bubble component. We provide applications to models of sovereign debt, private collateralized debt, and domestic public debt. Implications include an original equivalence mapping among distinct institutional arrangements, thereby clarifying the relationship between different enforcement mechanisms and the connection between asset and credit bubbles.

Keywords: Limited commitment, general equilibrium, rational credit bubbles

JEL Classification: E00, E10, F00

Suggested Citation

Martins-da-Rocha, V. Filipe and Phan, Toan and Vailakis, Yiannis, Debt Limits and Credit Bubbles in General Equilibrium (October 2, 2019). FRB Richmond Working Paper No. 19-19, Available at SSRN: https://ssrn.com/abstract=3473126

V. Filipe Martins-da-Rocha (Contact Author)

Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics

Rua Itapeva 474 s.1202
São Paulo, São Paulo 01332-000
Brazil

Toan Phan

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Yiannis Vailakis

University of Glasgow ( email )

University Avenue
Glasgow, Scotland G12 8QQ
United Kingdom

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