Endogenous Borrowing Constraints Research Articles

Human Capital Formation with Endogenous Credit Constraints

We study the accumulation of human capital and the behavior of consumption and earnings in a life cycle equilibrium model with endogenous borrowing constraints. Constraints arise endogenously from the inalienability of human capital and the limited punishments that creditors are able to impose on those who default. The endogeneity of borrowing constraints produces a number of interesting relationships. First, efficient borrowing limits are functions of individual observable characteristics and choices, especially ability and human capital investments. The connection between human capital investments and borrowing limits creates additional incentives to invest beyond those present in models with exogenous constraints. Second, government policies affect the incentives to default and, hence, the limits on private borrowing. As opposed to exogenous constraint models, additional subsidies for investment in human capital should be accompanied by increases in credit, since borrowers are more able to re-pay higher debts. Finally, general equilibrium considerations have an additional role, since borrowing limits depend on the returns to physical and human capital. We calibrate the model to U.S. data and are able to replicate key features of the economy regarding human capital investment, earnings, and consumption. The calibrated model is then used to study the steady state impacts of changes in government policies. We find that changes in bankruptcy laws can have sizeable effects on the accumulation of both human and physical capital. At the aggregate level, general equilibrium forces are important and can reverse the results predicted in partial equilibrium. Government subsidies to education (financed with a proportional tax on earnings) cause lenders to increase credit limits and substantially increase aggregate human and physical capital. Most importantly, we show that the implications of our model are very different from those of standard exogenous constraint models. For example, the effects of increases in initial wealth and government subsidies on investment are substantially greater in our model than in a similar model with exogenous constraints.

Collateralized Debt as the Optimal Contract

In a multiple-good risk-sharing environment with ex post private information, conditions are found under which collateralized debt is the optimal contract. The necessary and sufficient condition is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. Journal of Economic Literature Classification Numbers: D82, G10.

Optimal Lending Contracts and Firm Dynamics

We develop a general model of lending in the presence of endogenous borrowing constraints. Borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced. In the model, the dynamics of debt are closely linked with the dynamics of borrowing constraints. In fact, borrowing constraints must satisfy a dynamic consistency requirement: The value of outstanding debt restricts current access to short term capital, but is itself determined by future access to credit. This dynamic consistency is not guaranteed in models of exogenous borrowing constraints, where the ability to raise short term capital is limited by some prespecified function of debt. We characterize the optimal default-free contract - which minimizes borrowing constraints at all histories - and derive implications for firm growth, survival, leverage, and debt maturity. The model is qualitatively consistent with stylized facts on the growth and survival of firms. Comparative statics with respect to technology and default constraints are derived.

Collateralized Debt as the Optimal Contract

In a simple risk-sharing environment with ex post private information, conditions are found under which a collateralized debt contract is the optimal allocation. The critical condition for optimality is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. I argue that perhaps all debt contracts are implicitly collateralized.

Collateralized Debt as the Optimal Contract

In a simple risk-sharing environment with ex post private information, conditions are found under which a collateralized debt contract is the optimal allocation. The critical condition for optimality is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. I argue that perhaps all debt contracts are implicitly collateralized.

Endogenous Borrowing Constraints with Incomplete Markets

This article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models. The authors allow the constraints to depend on an investor's characteristics, such as time preference, risk aversion, and income streams. The proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default. Using a numerical algorithm, the authors find that, for an array of structural parameters, the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies. Copyright 1997 by American Finance Association.(This abstract was borrowed from another version of this item.)

Endogenous Borrowing Constraints With Incomplete Markets

ABSTRACTThis article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models. We allow the constraints to depend on an investor's characteristics such as time preference, risk aversion, and income streams. The proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default. Using a numerical algorithm, we find that for an array of structural parameters, the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies.