Optimal Contracts, Aggregate Risk, and the Financial Accelerator
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.
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Description: Full text
Provider: Federal Reserve Bank of Cleveland
Part of Series: Working Papers (Old Series)
Publication Date: 2014-10-16
Pages: 40 pages