Collateralized Debt as the Optimal Contract
60 Pages Posted: 21 Nov 2012
There are 3 versions of this paper
Collateralized Debt as the Optimal Contract
Collateralized Debt as the Optimal Contract
Collateralized Debt as the Optimal Contract
Date Written: May 6, 1998
Abstract
In a simple risk-sharing environment with ex post private information, conditions are found under which a collateralized debt contract is the optimal allocation. The critical condition for optimality is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. I argue that perhaps all debt contracts are implicitly collateralized.
Keywords: Debt, financial contracts, optimal contracts, asymmetric information, collateral, borrowing constraints
JEL Classification: D82, G10
Suggested Citation: Suggested Citation