NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Bankruptcy and Collateral in Debt Constrained Markets

Timothy J. Kehoe, David K. Levine

NBER Working Paper No. 12656
Issued in October 2006
NBER Program(s):   EFG   CF

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.

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Document Object Identifier (DOI): 10.3386/w12656

Published: Farmer, Roger E. A. (ed.) Macroeconomics in the Small and the Large: Essays on Microfoundations, Macroeconomic Applications, and Economic History in Honor of Axel Leijonhufvud. Northampton, MA: Edward Elgar Publishing, 2008.

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