Bankruptcy and Collateral in Debt Constrained Markets

21 Pages Posted: 20 Nov 2006 Last revised: 1 Aug 2022

See all articles by Timothy J. Kehoe

Timothy J. Kehoe

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

David K. Levine

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

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. 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)

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David K. Levine

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

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

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