In the presence of uninsurable idiosyncratic risk, the optimal credit contract allows for the possibility of default. In addition, the optimal contract incorporates a precautionary savings motive over and above what agents would otherwise save. When default is sufficiently high, credit markets...

This paper argues that in a homogeneous monetary Real Business Cycle economy where a complete set of nominal contingent claims exist, the requirement to collateralize loans, alone, does not affect the equilibrium allocation when monetary policy is chosen optimally: the Pareto optimal allocation...

The post-2008 period focused attention on "twin-crises". Banking crises may lead to sovereign crises where fiscal vulnerabilities are exacerbated by the extension of support for the banking system. We develop a model that describes private sector generated capital inflow that is used to finance...

Most discussions of the Greek debt overhang have focussed on the implications for Greece. We show that when additional funds released to the debtor (Greece), via debt restructuring, are used efficiently in pursuit of a practicable business plan, then both debtor and creditor can benefit. We...

This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each...

Busts after periods of prolonged prosperity have been found to be catastrophic. Financial institutions increase their leverage and shift their portfolios towards projects that were previously considered too risky. This results from institutions rationally updating their expectations and becoming...

This paper assesses the role that monetary policy plays in the decision to default using a General Equilibrium model with collateralized loans, trade in fiat money and production. Longterm nominal loans are backed by collateral, the value of which depends on monetary policy. The decision to...

We analyze a variant of the Diamond-Dybvig (1983) model of banking in which savers can use a bank to invest in a risky project operated by an entrepreneur. The savers can buy equity in the bank and save via deposits. The bank chooses to invest in a safe asset or to fund the entrepreneur. The...

We modify the Diamond and Dybvig (1983) model of banking to jointly study various regulations in the presence of credit and run risk. Banks choose between liquid and illiquid assets on the asset side, and between deposits and equity on the liability side. The endogenously determined asset...

 The purpose of this paper is to explore financial instability in this case due to a housing crisis and defaults on mortgages. The model incorporates heterogeneous banks and households. Mortgages are secured by collateral, which is equal to the amount of housing which agents purchase....