North-South Lending with Moral Hazard and Repudiation Risk

REVIEW OF INTERNATIONAL ECONOMICS

Posted: 12 Jun 1997

See all articles by Philip R. Lane

Philip R. Lane

Trinity College (Dublin) - Department of Economics; Centre for Economic Policy Research (CEPR); Central Bank of Ireland

Abstract

We show that the joint presence of moral hazard and repudiation risk generates an important interaction effect. In order to provide the proper incentives to borrowers, the optimal financial contract under moral hazard calls for all available resources to be paid to the lender in the event of a poor realization for output. Repudiation risk limits the size of this transfer, as the debtor has the option to default. This upper bound on the resource transfer exacerbates the moral hazard problem, reducing lending and the equilibrium level of investment and output.

JEL Classification: E44, F21, F34

Suggested Citation

Lane, Philip R., North-South Lending with Moral Hazard and Repudiation Risk. REVIEW OF INTERNATIONAL ECONOMICS. Available at SSRN: https://ssrn.com/abstract=8683

Philip R. Lane (Contact Author)

Trinity College (Dublin) - Department of Economics ( email )

Trinity College
Dublin 2
Ireland
+353 1 608 2259 (Phone)
+353 1 677 2503 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Central Bank of Ireland ( email )

P.O. Box 559
Dame Street
Dublin, 2
Ireland

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