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Savings and Default

50 Pages Posted: 7 Nov 2011  

Udara Peiris

National Research University Higher School of Economics - International College of Economics and Finance

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Date Written: September 7, 2011

Abstract

In the presence of uninsurable idiosyncratic risk, the optimal credit contract allows for the possibility of default. In addition, the optimal contract incorporates a precautionary savings motive over and above what agents would otherwise save. When default is sufficiently high, credit markets may collapse. A regulatory requirement on the level of savings can increase risk-sharing and improve welfare by increasing the gains to trade in credit exchange. Under the appropriate verifiability condition on the level of savings, an appropriate market structure, agents voluntarily increase their level of storage such that trade and welfare improve.

Keywords: Uninsurable Risk, Credit, Default, Endogenous Contracts, Precautionary Savings

JEL Classification: D52, D53, E21

Suggested Citation

Peiris, Udara and Vardoulakis, Alexandros, Savings and Default (September 7, 2011). Available at SSRN: https://ssrn.com/abstract=1955941 or http://dx.doi.org/10.2139/ssrn.1955941

Udara Peiris (Contact Author)

National Research University Higher School of Economics - International College of Economics and Finance ( email )

Pokrovski Bulvar 11, Korpus Zh, Office 715
Moscow, 109028
Russia

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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