Equilibrium Debt Financing
44 Pages Posted: 19 Mar 2010 Last revised: 12 Mar 2012
Date Written: December 30, 2010
Building on Geanakoplos (2009), we study an equilibrium model of an asset market with cash-constrained optimists using their asset positions as collateral to raise debt financing. By using a general binomial setting with time-varying belief dispersion between agents, we highlight an asset's marketability as an important determinant of its collateral value. This is because the availability of secondary market trading allows creditors to sell seized collateral to other optimists with saved cash, which, in turn, not only boosts creditors' initial valuation of the collateral but also motivates optimists to save cash. Our model also establishes the maximum riskless short-term debt as the only debt contract used in the equilibrium and a risk-neutral representation of the equilibrium asset price and prices of debt contracts collateralized by the asset.
Keywords: Marketability, Collateral value, Debt maturity
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