Bankruptcy and Collateral in Debt Constrained Markets

21 Pages Posted: 20 Nov 2006  

Timothy J. Kehoe

University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

David K. Levine

Washington University in St. Louis - Department of Economics; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS)

Date Written: October 2006

Abstract

Typical models of bankruptcy and collateral rely on incomplete asset markets. In fact, bankruptcy and collateral add contingencies to asset markets. In some models, these contingencies can be used by consumers to achieve the same equilibrium allocations as in models with complete markets. In particular, the equilibrium allocation in the debt constrained model of Kehoe and Levine (2001) can be implemented in a model with bankruptcy and collateral. The equilibrium allocation is constrained efficient. Bankruptcy occurs when consumers receive low income shocks. The implementation of the debt constrained allocation in a model with bankruptcy and collateral is fragile in the sense of Leijonhufvud's "corridor of stability," however: If the environment changes, the equilibrium allocation is no longer constrained efficient.

Suggested Citation

Kehoe, Timothy J. and Levine, David K., Bankruptcy and Collateral in Debt Constrained Markets (October 2006). NBER Working Paper No. w12656. Available at SSRN: https://ssrn.com/abstract=940605

Timothy J. Kehoe (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
1169 Management & Economics
Minneapolis, MN 55455
United States
612-625-1589 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David K. Levine

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States

HOME PAGE: http://www.dklevine.com

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

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