Optimal Contracts, Aggregate Risk, and the Financial Accelerator

Carlstrom, Charles T.; Fuerst, Timothy S.; Paustian, Matthias

doi:10.2139/ssrn.2510783

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Optimal Contracts, Aggregate Risk, and the Financial Accelerator

FRB of Cleveland Working Paper No. 14-20

40 Pages Posted: 23 Oct 2014

See all articles by Charles T. Carlstrom

Matthias Paustian

Bank of England

There are 2 versions of this paper

Date Written: October 15, 2014

Abstract

This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (1999), hereafter BGG. The optimal contract includes indexation to the aggregate return on capital, household consumption, and the return to internal funds. This triple indexation results in a dampening of fluctuations in leverage and the risk premium. Hence, compared with the contract originally imposed by BGG, the privately optimal contract implies essentially no financial accelerator.

(A previous version of this paper was titled “Privately Optimal Contracts and Suboptimal Outcomes in a Model of Agency Costs”).

Keywords: agency costs, CGE models, optimal contracting

JEL Classification: C68, E44, E61

Suggested Citation: Suggested Citation

Carlstrom, Charles T. and Fuerst, Timothy S. and Paustian, Matthias, Optimal Contracts, Aggregate Risk, and the Financial Accelerator (October 15, 2014). FRB of Cleveland Working Paper No. 14-20, Available at SSRN: https://ssrn.com/abstract=2510783 or http://dx.doi.org/10.2139/ssrn.2510783