Optimal Lending Contracts and Firm Dynamics

We develop a general model of lending in the presence of endogenous borrowing constraints. Borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced. In the model, the dynamics of debt are closely linked with the dynamics of borrowing constraints. In fact, borrowing constraints must satisfy a dynamic consistency requirement: The value of outstanding debt restricts current access to short term capital, but is itself determined by future access to credit. This dynamic consistency is not guaranteed in models of exogenous borrowing constraints, where the ability to raise short term capital is limited by some prespecified function of debt. We characterize the optimal default-free contract -which minimizes borrowing constraints at all histories- and derive implications for firm growth, survival, and leverage. The model is qualitatively consistent with stylized facts on the growth and survival of firms. Comparative statics with respect to technology and default constraints are derived.Financial constraints, imperfect enforcement, firm dynamics, capital structure, debt maturity.

A Simple Model of Capital Imports

Following Ramsey (1928) theoretical framework, this paper develops a dynamic model where a community is assumed to be importing two forms of foreign capital: external debt and foreign direct investment (FDI). The community is assumed to derive utility from consumption of goods and positive externalities of FDI, while deriving disutility from negative externalities of external borrowing. Results suggest that: first, a higher disutility of debt implies a higher shadow interest rate.1 The higher the utility derived from FDI, however, the lower the shadow interest rate. Second, external borrowing will be attractive as long as the relevant interest rate is less or equal to the net marginal product of capital. Third, the study of the social optimum shows that the externalities that arise from foreign capital do not affect the steady state which is always a saddle point.External borrowing, External debt, Dynamic optimization

Joint-liability borrowing decisions under risk: Empirical evidence from rural microfinance in Ethiopia

This paper investigates borrowing decisions of rural households from a microfinance in Tigray, Ethiopia using household panel data on 5 years and a dynamic panel probit model. The theoretical model takes two types of risk involved in joint-liability lending explicitly into account: risk of partner failure and the risk of losing future access to credit. Empirical results show that these risks are important in explaining borrowing decisions. Another finding is that the probability of repeat-borrowing is higher than the probability of new participation, with possible implications that perceived joint-liability threats deter participation and easing stringent punishments might help poor households’ access to credit.Microfinance, risk, dynamic panel probit, Financial Economics,

Prices versus Quantities versus Bankable Quantities

Welfare comparisons of regulatory instruments under uncertainty, even in dynamic analyses, have typically focused on price versus quantity controls despite the presence of banking and borrowing provisions in existing emissions trading programs. This is true even in the presence of banking and borrowing provisions in existing emissions trading programs. Nonetheless, many have argued that such provisions can reduce price volatility and lower costs in the face of uncertainty, despite any theoretical or empirical evidence. This paper develops a model and solves for optimal banking and borrowing behavior with uncertain cost shocks that are serially correlated. We show that while banking does reduce price volatility and lowers costs, the degree of these reductions depends on the persistence of shocks. For plausible parameter values related to U.S. climate change policy, we find that bankable quantities eliminate about 20 percent of the cost difference between price and nonbankable quantities.welfare, prices, quantities, climate change

Job search and asset accumulation under borrowing constraints.

In this paper I show how borrowing constraints and job search interact. I fit a dynamic model to data from the National Longitudinal Survey (1979-cohort) and show that borrowing constraints are significant. Agents with more initial assets and more access to credit attain higher wages for several periods after high school graduation. The unemployed maintain their consumption by running down their assets, while the employed save to buffer against future unemployment spells. I also show that, unlike in models with exogenous income streams, unemployment transfers, by allowing agents to attain higher wages do not 'crowd out' but increase saving.

Amplifying Business Cycles through Credit Constraints

Theory suggests that endogenous borrowing constraints amplify the impact of external shocks on the economy. How big is the amplification? In this paper, we quantitatively investigate this question in the context of a dynamic general equilibrium model with borrowing constraints under two alternatives: (1) borrowing constraint endogenously depends on the borrower's net worth (2) borrowing constraint is exogenous. Calibrating our model to the Japanese economy, we find evidence of significant amplification in our impulse responses. Quantitatively applying the model to the Japanese case, we find TFP can significantly account for the Japanese business cycle during the period 1980 to 2000 and the impact is much amplified when we assume that borrowing constraints are endogenously determined.Borrowing constraint; Endogenous; Net worth; Business cycle; Amplification

Threshold effects in international lending

The author's dynamic model of international borrowing subject to credit constraint was developed for an economy with increasing returns to physical capital. Increases in the capital stock within the nonconvex range increase debtor borrowing opportunities. Conversely, a temporary liquidity shock may permanently lower the economy's growth path. Introducing aggregate nonconvexities also has different implications for policy on debt overhangs. In particular, the model allows for rational relending by creditors. It also predicts that new money ( or interest capitalization ) is in the interest of creditors and will be part of a debt restructuring strategy - as it was recently for Mexico and the Philippines.Economic Theory&Research,Banks&Banking Reform,Economic Growth,Environmental Economics&Policies,Housing Finance

Borrowing Constraints, Entrepreneurial Risks, and the Wealth Distribution in a Heterogeneous Agent Model

This paper deals with credit market imperfections and idiosyncratic risks in a two–sector heterogeneous agent dynamic general equilibrium model of occupational choice. We focus especially on the effects of tightening financial constraints on macroeconomic performance, entrepreneurial risk–taking, and social mobility. Contrary to many models in the literature, our comparative static results cover the entire range of borrowing constraints, from complete markets to a perfectly constrained economy. In our baseline model, we find substantial gains in output, welfare, and wealth equality associated with relaxing the constraints, but argue that it might also prove worthwhile to examine the marginal gains from credit market improvements. Interestingly, the amount of entrepreneurial activity and social mobility increases if borrowing constraints become more tight. These results can be attributed to the general equilibrium nature of our approach, where optimal firm sizes and the demand for credit are determined endogenously. The comparative static results on the entrepreneurship rate and social mobility respond sensitively to a change in income persistence.DSGE model, wealth distribution, occupational choice, borrowing constraints

Learning to coordinate in a complex and non-stationary world

We study analytically and by computer simulations a complex system of adaptive agents with finite memory. Borrowing the framework of the Minority Game and using the replica formalism we show the existence of an equilibrium phase transition as a function of the ratio between the memory $\lambda$ and the learning rates $\Gamma$ of the agents. We show that, starting from a random configuration, a dynamic phase transition also exists, which prevents the system from reaching any Nash equilibria. Furthermore, in a non-stationary environment, we show by numerical simulations that agents with infinite memory play worst than others with less memory and that the dynamic transition naturally arises independently from the initial conditions.Comment: 4 pages, 3 figure

Maximising Survival, Growth, and Goal Reaching Under Borrowing Constraints

In this paper, we consider three problems related to survival, growth, and goal reaching maximization of an investment portfolio with proportional net cash flow. We solve the problems in a market constrained due to borrowing prohibition. To solve the problems, we first construct an auxiliary market and then apply the dynamic programming approach. Via our solutions, an alternative approach is introduced in order to solve the problems defined under an auxiliary market