With Additional Enforcement Mechanisms, does Collateral Avoid Ponzi Schemes?

Abstract

In infinite horizon incomplete market economies, when the seizure of collateral guarantees is the only mechanism enforcing borrowers not to entirely default on their promises, equilibrium exists independently of the choice of collateral bundles. In these economies, we analyze if generic additional enforcement mechanisms besides the seizure of collateral guarantees may eliminate the existence of physical feasible individuals’ optimal plans. For this, we only need to focus on the decision problem of a price taker individual and on the effectiveness of the additional enforcement mechanisms, i.e. the amount of payments besides the value of collateral guarantees. Then, we show that there is a relationship between collateral requirements and the effectiveness of such additional mechanisms implying the non-existence of a solution for the individual’s problem.