Robust bubbles with mild penalties for default

Limited enforcement of debt contracts and mild penalties for default can lead to low equilibrium interest rates, to ensure debt repayment. Low interest rates, in turn, create conditions for bubbles. I show that bubbles in unsecured private debt exist when the punishment for default is a permanent or...

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Bibliographic Details
Published in:Journal of mathematical economics 2016-08, Vol.65, p.141-153
Main Author: Bidian, Florin
Format: Article
Language:English
Subjects:
Bubbles
Default
Economic crisis
Endogenous debt limits
Fines & penalties
Inside liquidity
Interest rates
Outside liquidity
Repayments
Risk-sharing
Self-enforcing debt
Studies
Welfare economics
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Summary:Limited enforcement of debt contracts and mild penalties for default can lead to low equilibrium interest rates, to ensure debt repayment. Low interest rates, in turn, create conditions for bubbles. I show that bubbles in unsecured private debt exist when the punishment for default is a permanent or a temporary interdiction to trade. Bubbles are an inefficient source of liquidity, as they lower interest rates and reduce welfare by discouraging saving.
ISSN:0304-4068
1873-1538
DOI:10.1016/j.jmateco.2015.04.002