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Robust bubbles with mild penalties for default

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  • Bidian, Florin

Abstract

Limited enforcement of debt contracts and mild penalties for default can lead to low equilibrium interest rates, to ensure debt repayment. Low interest rates, in turn, create conditions for bubbles. I show that bubbles in unsecured private debt exist when the punishment for default is a permanent or a temporary interdiction to trade. Bubbles are an inefficient source of liquidity, as they lower interest rates and reduce welfare by discouraging saving.

Suggested Citation

  • Bidian, Florin, 2016. "Robust bubbles with mild penalties for default," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 141-153.
    • Handle: RePEc:eee:mateco:v:65:y:2016:i:c:p:141-153
    DOI: 10.1016/j.jmateco.2015.04.002
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