Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral. Our Binomial No-Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no...

We review the theory of leverage developed in collateral equilibrium models with incomplete markets. We explain how leverage tends to boost asset prices and create bubbles. We show how leverage can be endogenously determined in equilibrium and how it depends on volatility. We describe the...

We show how vicious circles in countries’ credit histories arise in a model where output persistence is coupled with asymmetric information between borrowers and lenders about the nature of output shocks. In such an environment, default creates a pessimistic outlook about the borrower’s...