Endogenous Credit Limits with Small Default Costs

FRB of St. Louis Working Paper No. 2012-048A

26 Pages Posted: 24 Oct 2012

See all articles by Costas Azariadis

Costas Azariadis

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Leo Kaas

University of Konstanz - Faculty of Economics and Statistics; IZA Institute of Labor Economics

Date Written: October 1, 2012

Abstract

We analyze an exchange economy of unsecured credit where borrowers have the option to declare bankruptcy in which case they are temporarily excluded from financial markets. Endogenous credit limits are imposed that are just tight enough to prevent default. Economies with temporary exclusion differ from their permanent exclusion counterparts in two important properties. If households are extremely patient, then the first–best allocation is an equilibrium in the latter economies but not necessarily in the former. In addition, temporary exclusion permits multiple stationary equilibria, with both complete and with incomplete consumption smoothing.

Keywords: bankruptcy, endogenous solvency constraints

JEL Classification: D91, G33

Suggested Citation

Azariadis, Costas and Kaas, Leo, Endogenous Credit Limits with Small Default Costs (October 1, 2012). FRB of St. Louis Working Paper No. 2012-048A. Available at SSRN: https://ssrn.com/abstract=2166095 or http://dx.doi.org/10.2139/ssrn.2166095

Costas Azariadis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Leo Kaas

University of Konstanz - Faculty of Economics and Statistics ( email )

Universitaetsstr. 10
78457 Konstanz
Germany

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Register to save articles to
your library

Register

Paper statistics

Downloads
16
Abstract Views
269
PlumX Metrics