Asset prices, debt constraints and inefficiency

In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained ine±ciency corresponds to a feasible redistribution yielding a welfare improvement beginning from ev- ery contingency reached by the economy. A sort of Cass Criterion (Cass [10]) completely characterizes constrained ine±ciency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare im- provement, subject to participation, coincides with the introduced notion of constrained ine±ciency.Private debt; solvency constraints; default; Cass Criterion; asset

Money Creation: Tax or Public Liquidity?

I revisit the example of non-neutral anticipated monetary expansions used in Lucas (1995) Nobel Prize Lecture, within a broader definition of monetary policy tools, such as paying a nominal return on money or using open market operations, to show that money expansions increase output by reallocating consumption across heterogenous individuals and time periods. This result survives with non interest-bearing cash when the latter does not generate relevant distortions

Indeterminacy of competitive equilibrium with risk of default

We prove indeterminacy of competitive equilibrium in sequential economies, where limited commitment requires the endogenous determination of solvency constraints preventing debt repudiation (Alvarez and Jermann [3]). In particular, we show that, for any arbitrary value of social welfare in between autarchy and (constrained) optimality, there exists an equilibrium attaining that value. Our method consists in restoring Welfare Theorems for a weak notion of (constrained) optimality. The latter, inspired by Malinvaud [15], corresponds to the absence of Pareto improving feasible redistributions over nite (though inde nite) horizons.imited commitment; solvency constraints; Malinvaud efficiency Welfare Theorems; indeterminacy; Welfare Theorems; indeterminacy; Welfare Theorems indeterminacy;financial fragility; market collapse

Asset Prices, Debt Constraints and Inefficiency

In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained ine±ciency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass [10]) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained ine±ciency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass [10]) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.Non-Refereed Working Papers / of national relevance onl

Optimal debt contracts and moral hazard along the business cycle

We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.Refereed Working Papers / of international relevanc

Risk and intermediation in a dual financial market economy

We study the competitive equilibria of a simple economy with moral hazard and intermediation costs. Entrepreneurs can simultaneously get credit from two types of competing institutions: ‘financial intermediaries’ and ‘local lenders’. The former are competitive firms issuing deposits and having a comparative advantage in diversifying credit risks. The latter are individuals with a comparative advantage in credit arrangements with a ‘nearby’ entrepreneur. Because of intermediation costs, local lenders are willing to diversify their portfolio by offering some direct lending to nearby entrepreneurs. We show that, in some cases, a fall in intermediation costs, by inducing local lenders to choose a safer portfolio, reduces entrepreneurs’ effort and increases the probability of default. In these cases, taxing intermediaries may be welfare-improving.We study the competitive equilibria of a simple economy with moral hazard and intermediation costs. Entrepreneurs can simultaneously get credit from two types of competing institutions: ‘financial intermediaries’ and ‘local lenders’. The former are competitive firms issuing deposits and having a comparative advantage in diversifying credit risks. The latter are individuals with a comparative advantage in credit arrangements with a ‘nearby’ entrepreneur. Because of intermediation costs, local lenders are willing to diversify their portfolio by offering some direct lending to nearby entrepreneurs. We show that, in some cases, a fall in intermediation costs, by inducing local lenders to choose a safer portfolio, reduces entrepreneurs’ effort and increases the probability of default. In these cases, taxing intermediaries may be welfare-improving.Non-Refereed Working Papers / of national relevance onl

Adverse Selection of Investment Projects and the Business Cycle

In an economy where entrepreneurs with unequal "abilities" face alternative investment projects, which differ in degree of risk and productivity, we analyse the Nash equilibrium contracts arising from a banks-borrowers game in the context of asymmetric information. We show that, for a particular characterization of the game, one can determine the endogenous distribution of projects and the "type" of contracts (pooling or separating) as functions of the amount of loanable funds. We set this game in a general equilibrium aggregative economy with production, populated by overlapping generations of borrowers and lenders and show that for a range of the parameter values equilibria are characterized by persistent endogenous cycles.adverse selection, business cycles, investment projects

A Negishi’s Approach to Competitive Equilibrium with Risk of Default

We study competitive equilibrium in sequential economies under limited commitment. Default induces permanent exclusion from nancial markets and endogenously determined solvency constraints prevent debt repudiation. We establish Welfare Theorems under a weaker notion of constrained efficiency, inspired by Malinvaud, corresponding to the absence of welfare improving feasible redistributions over nite (though indenite) horizons. A Negishi's Method permits to show that, for any arbitrary value of social welfare in between autarchy and constrained optimality, there exists an equilibrium attaining that value. This method is also exploited to verify equilibrium indeterminacy.We study competitive equilibrium in sequential economies under limited commitment. Default induces permanent exclusion from nancial markets and endogenously determined solvency constraints prevent debt repudiation. We establish Welfare Theorems under a weaker notion of constrained efficiency, inspired by Malinvaud, corresponding to the absence of welfare improving feasible redistributions over nite (though indenite) horizons. A Negishi's Method permits to show that, for any arbitrary value of social welfare in between autarchy and constrained optimality, there exists an equilibrium attaining that value. This method is also exploited to verify equilibrium indeterminacy.Non-Refereed Working Papers / of national relevance onl

Explaning the Correlation Between Output and Volatility in a Model of International Risk-Sharing and Limited Commitment

I study the constrained efficient allocations of a simple model of risk sharing and capital flows across countries assuming that each country cannot commit to fully repay its contract obligations. In the model, the degree of risk sharing and the amount of investment are interdependent. It is shown that, when individual rationality constraints are binding, the variance of consumption in any given country across states of nature (iid across countries) may be a non monotonic function of income: low in the early stage of development, high in an intermediate range and converging to zero as income converges to a high income level. A monotonically decreasing consumption variance can only obtain if the social welfare function assigns equal weights to all countries (equal treatment). The model also shows that a structure of competitive financial markets with appropriate borrowing constraints may not be sufficient to decentralize the constrained efficient allocation. A supernational authority forcing a specific redistribution of income within poorly capitalized countries may be necessary for decentralization.I study the constrained efficient allocations of a simple model of risk sharing and capital flows across countries assuming that each country cannot commit to fully repay its contract obligations. In the model, the degree of risk sharing and the amount of investment are interdependent. It is shown that, when individual rationality constraints are binding, the variance of consumption in any given country across states of nature (iid across countries) may be a non monotonic function of income: low in the early stage of development, high in an intermediate range and converging to zero as income converges to a high income level. A monotonically decreasing consumption variance can only obtain if the social welfare function assigns equal weights to all countries (equal treatment). The model also shows that a structure of competitive financial markets with appropriate borrowing constraints may not be sufficient to decentralize the constrained efficient allocation. A supernational authority forcing a specific redistribution of income within poorly capitalized countries may be necessary for decentralization.Non-Refereed Working Papers / of national relevance onl