Abstract
The paper studies creditworthiness in a model with endogenous credit cost and debt constraints. Such a model can give rise to multiple candidates for steady state equilibria. We use new analytical techniques such as dynamic programming (DP) with flexible grid size to find solutions and to locate thresholds that separate different domains of attraction. More specifically, we (1) compute present value borrowing constraints and thus creditworthiness, (2) locate thresholds where the dynamics separate to different domains of attraction, (3) show jumps in the decision variable, (4) distinguish between optimal and non-optimal steady states, (5) demonstrate how creditworthiness and thresholds change with change of the credit cost function of the debtor and (6) explore the impact of debt ceilings and consumption paths on creditworthiness.
Highlights
Numerous examples of dynamic economic models with multiple equilibria exist in the economic literature. 1 Yet, only recently it has been discovered that the study of the local dynamics needs to be complemented by the study of the global dynamics
We (1) compute the present value borrowing constraint and creditworthiness without and with endogenous credit cost, (2) compute thresholds of those types of models where the dynamics separate to different domains of attraction, (3) show that the policy function may be discontinuous and compute the jumps in the policy function, (4) distinguish between optimal and non-optimal steady states and (5) demonstrate how the thresholds change with change of the credit cost function and (6) compute creditworthiness curves and thresholds for model variants with debt ceilings and given consumption paths
We study a credit market model where the agents can borrow from credit market for investment and where the credit cost may be state dependent and the agents may face debt ceilings
Summary
Numerous examples of dynamic economic models with multiple equilibria exist in the economic literature. 1 Yet, only recently it has been discovered that the study of the local dynamics needs to be complemented by the study of the global dynamics. Often the so called transversality condition is invoked to provide a statement on the non-explosiveness of the debt of the economic agents Models of this type have been discussed in the literature for households, firms, governments and countries (with access to international capital markets).[3] Here as long as the intertemporal budget constraint holds, the intertemporal creditworthiness is automatically fulfilled for sufficiently small initial debt. We (1) compute the present value borrowing constraint and creditworthiness without and with endogenous credit cost, (2) compute thresholds of those types of models where the dynamics separate to different domains of attraction, (3) show that the policy function may be discontinuous and compute the jumps in the policy function, (4) distinguish between optimal and non-optimal steady states and (5) demonstrate how the thresholds change with change of the credit cost function and (6) compute creditworthiness curves and thresholds for model variants with debt ceilings and given consumption paths.
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