DP6040 Optimal Debt Contracts under Costly Enforcement
|Author(s):||Hans K Hvide, Tore Leite|
|Publication Date:||January 2007|
|Keyword(s):||Costly state verification, debt contract, priority violation, strategic defaults|
|JEL(s):||D02, D82, G21, G33|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6040|
We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behaviour in credit markets.