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The Optimal Price of Default

Author

Listed:
  • Wei Ma

    (Deptartment of manufacturing Engineering & Engineering Management, City University of Hong Kong)

  • Chuangyin Dang

    (Deptartment of manufacturing Engineering & Engineering Management, City University of Hong Kong)

Abstract

With assets taken to be pools, rational expectations on their delivery rates are, as default is permissible in an economy and its penalty prescribed in terms of utility, indispensable to the existence of equilibrium. And the resulting equilibrium relies heavily on the prevailing penalty level. We propose, in this paper, a path-following algorithm for calculating the level of penalty that leads to a Pareto efficient equilibrium—Pareto efficient among the set of equilibria of the economies with distinct penalty levels. This algorithm brings off those rational expectations by identifying their upper and lower bounds iteratively until the discrepancies between them are admissible.

Suggested Citation

  • Wei Ma & Chuangyin Dang, 2013. "The Optimal Price of Default," Annals of Economics and Finance, Society for AEF, vol. 14(1), pages 145-167, May.
    • Handle: RePEc:cuf:journl:y:2013:v:14:i:1:ma:dang
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Default; Penalty; Path-following; Pareto efficiency; Rational expectation;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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