Debt Limits and Credit Bubbles in General Equilibrium
Abstract: We provide a novel characterization of self-enforcing debt limits in a general equilibrium framework of risk sharing with limited commitment, where defaulters are subject to recourse (a fractional loss of current and future endowments) and exclusion from future credit. We show that debt limits are exactly equal to the present value of recourse plus a credit bubble component. We provide applications to models of sovereign debt, private collateralized debt, and domestic public debt. Implications include an original equivalence mapping among distinct institutional arrangements, thereby clarifying the relationship between different enforcement mechanisms and the connection between asset and credit bubbles.
File format is application/pdf
Description: Full text
Provider: Federal Reserve Bank of Richmond
Part of Series: Working Paper
Publication Date: 2019-10-11
Pages: 47 pages