Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/97335 
Year of Publication: 
2013
Series/Report no.: 
Working Paper No. 711
Publisher: 
Queen Mary University of London, School of Economics and Finance, London
Abstract: 
This paper studies economies with complete markets where there is positive default on consumer debt. In a simple tractable two-period model, households can default partially, at a finite punishment cost, and competitive intermediaries price loans of different sizes separately. This environment yields only partial insurance. The default-based pricing of debt makes it too costly for the borrower to achieve full insurance and there is too little trade in securities. This framework is in contrast with existing literature. Unlike the literature with default, there are no restrictions on the set of state contingent securities that are issued. Unlike the literature on lack of commitment, limited trade arises without need of debt constraints that rule default out. Compared with the latter, the present approach appears to imply more consumption inequality. An extended model with an infinite horizon, idiosyncratic risk and more realistic assumptions is used to demonstrate the general validity of this approach and its main implications.
Subjects: 
Consumer default
Complete markets
Endogenous incomplete markets
Risk-based pricing
Risk sharing
JEL: 
E21
E44
D52
Document Type: 
Working Paper

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