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A Model of Dynamic Liquidity Contracts

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  • ÖZGÜR, Onur

Abstract

I study long-term financial contracts between lenders and borrowers in the absence of perfect enforceability and when both parties are credit constrained. Borrowers repeatedly have projects to undertake and need external financing. Lenders can commit to contractual agreements whereas borrowers can renege any period. I show that equilibrium contracts feature interesting dynamics: the economy exhibits efficient investment cycles; absence of perfect enforcement and shortage of capital skew the cycles toward states of liquidity drought; credit is rationed if either the lender has too little capital or if the borrower has too little collateral. This paper's technical contribution is its demonstration of the existence and characterization of financial contracts that are solutions to a non-convex dynamic programming problem.

Suggested Citation

  • ÖZGÜR, Onur, 2011. "A Model of Dynamic Liquidity Contracts," Cahiers de recherche 2011-06, Universite de Montreal, Departement de sciences economiques.
    • Handle: RePEc:mtl:montde:2011-06
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    File URL: https://papyrus.bib.umontreal.ca/xmlui/handle/1866/6001
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    More about this item

    Keywords

    Credit Rationing; credit cycles; default; limited capital; liquidity.;
    All these keywords.

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • G2 - Financial Economics - - Financial Institutions and Services

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