Robust bubbles with mild penalties for default |
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| Institution: | 1. Department of Economics, Boston College, 140 Commonwealth Avenue, Chestnut Hill, MA 02467, USA;2. Toulouse School of Economics, Toulouse, France;3. Department of Economics and Accounting, College of the Holy Cross, 1 College Street, Worcester, MA 01610, USA;1. Department of Economics and Management, Université de Cergy-Pontoise & THEMA, Cergy-Pontoise, 95011, France;2. Department of Economics, University of Georgia, Athens, GA, 30602, USA |
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| Abstract: | 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. |
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| Keywords: | Bubbles Self-enforcing debt Inside liquidity Outside liquidity Endogenous debt limits Risk-sharing |
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