Working Paper
Collateralized debt as the optimal contract
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.
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Provider: Federal Reserve Bank of Richmond
Part of Series: Working Paper
Publication Date: 1998
Number: 98-04
Note: Also published as 90-3R2