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Credit Risk without Commitment

Author

Listed:
  • Leonardo Martinez

    (International Monetary Fund)

  • Juan Hatchondo

    (Indiana University)

Abstract
We study economies with credit risk in which, each period, borrowers cannot commit to borrow from only one lender. We extend the analysis in Bizer and DeMarzo (1992) by allowing for multiple borrowing periods. In particular, we remove the exclusive-borrowing- contract assumption from a quantitative model of household bankruptcy a la Chatterjee et al. (2007). We compare equilibrium allocations with and without commitment to exclusive contracts. In contrast with Bizer and DeMarzo (1992), we find that borrowing levels are much lower without commitment. Imposing commitment increases the average debt-to-income ratio in the simulations from 9% to 16%. This is the case because (i) the cost of defaulting is lower without commitment and (ii) only without commitment, an increase in current borrowing levels deteriorates future borrowing opportunities. These effects are not relevant in Bizer and DeMarzo’s (1992) model with a unique borrowing period. In contrast with the standard household bankruptcy model and consistently with the data, the model without commitment features (i) borrowing opportunities that resemble credit lines, (ii) borrowing opportunities that depend on the borrowing history (credit score), (iii) credit rationing, and (iv) a higher dispersion of interest rates across households. Introducing an interest rate limit to deal with the non-exclusivity problem produces ex-ante welfare gains equivalent to a permanent increase in consumption of 0.7%.

Suggested Citation

  • Leonardo Martinez & Juan Hatchondo, 2017. "Credit Risk without Commitment," 2017 Meeting Papers 1326, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:1326
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    References listed on IDEAS

    as
    1. Juan Carlos Hatchondo & Leonardo Martinez & Francisco Roch, 2022. "Fiscal Rules and the Sovereign Default Premium," American Economic Journal: Macroeconomics, American Economic Association, vol. 14(4), pages 244-273, October.
    2. Alberto Bisin & Danilo Guaitoli, 2004. "Moral Hazard and Nonexclusive Contracts," RAND Journal of Economics, The RAND Corporation, vol. 35(2), pages 306-328, Summer.
    3. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 37-54.
    4. Victor Rios-Rull & Dean Corbae: & Satyajit Chatterjee, 2011. "A Theory of Credit Scoring and the Competitive Pricing of Default Risk," 2011 Meeting Papers 1115, Society for Economic Dynamics.
    5. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
    6. Carlos Hatchondo, Juan & Martinez, Leonardo & Sánchez, Juan M., 2015. "Mortgage defaults," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 173-190.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
      • Mr. Leonardo Martinez & Juan Carlos Hatchondo & Mr. Juan M. Sanchez, 2012. "Mortgage Defaults," IMF Working Papers 2012/026, International Monetary Fund.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2015. "Mortgage Defaults," CAEPR Working Papers 2015-011, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    7. Juan Carlos Hatchondo & Leonardo Martinez & César Sosa-Padilla, 2016. "Debt Dilution and Sovereign Default Risk," Journal of Political Economy, University of Chicago Press, vol. 124(5), pages 1383-1422.
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    17. Greg Kaplan & Giovanni L. Violante, 2010. "How Much Consumption Insurance beyond Self-Insurance?," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 53-87, October.
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    Cited by:

    1. Gajendran Raveendranathan & Georgios Stefanidis, 2020. "The Unprecedented Fall in U.S. Revolving Credit," Department of Economics Working Papers 2020-05, McMaster University.
    2. Bornstein, Gideon, 2020. "A Continuous-Time Model of Sovereign Debt," Journal of Economic Dynamics and Control, Elsevier, vol. 118(C).
    3. Zachary Bethune & Joaquín Saldain & Eric R. Young, 2024. "Consumer Credit Regulation and Lender Market Power," Staff Working Papers 24-36, Bank of Canada.
    4. Gajendran Raveendranathan & Georgios Stefanidis, 2022. "Designing “Win-Win” Rate Caps," Department of Economics Working Papers 2022-03, McMaster University.

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