Collateralized Debt as the Optimal Contract

60 Pages Posted: 21 Nov 2012

Multiple version iconThere are 3 versions of this paper

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

Lacker, Jeffrey M., Collateralized Debt as the Optimal Contract (May 6, 1998). FRB Richmond Working Paper No. 98-4, Available at SSRN: https://ssrn.com/abstract=2123682 or http://dx.doi.org/10.2139/ssrn.2123682

Jeffrey M. Lacker (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8279 (Phone)
804-697-8461 (Fax)

HOME PAGE: http://www.richmondfed.org

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