## Abstract

Much of the lending in modern economies is secured by some form of collateral: residential and commercial mortgages and corporate bonds are familiar examples. This paper builds an extension of general equilibrium theory that incorporates durable goods, collateralized securities, and the possibility of default to argue that the reliance on collateral to secure loans and the particular collateral requirements chosen by the social planner or by the market have a profound impact on prices, allocations, market structure, and the efficiency of market outcomes. These findings provide insights into housing and mortgage markets, including the subprime mortgage market.

## Keywords

Collateral Default GEI## JEL Classification

D5## References

- Araujo, A., Fajardo, J., Pascoa, M.: Endogenous collateral. J. Math. Econ.
**41**, 439–462 (2005)CrossRefGoogle Scholar - Araujo, A., Kubler, F., Schommer, S.: Regulating collateral requirements when markets are incomplete. J. Econ. Theory
**147**, 450–476 (2012)CrossRefGoogle Scholar - Araujo, A., Pascoa, M., Torres-Martinez, J.: Collateral avoids ponzi schemes in incomplete markets. Econometrica
**70**, 1613–1638 (2002)CrossRefGoogle Scholar - Barrett, R.: Collateral in temporary equilibrium. Dissertation, UCLA (2000)Google Scholar
- Bernanke, B., Gertler, M., Gilchrist, S.: The financial accelerator and the flight to quality. Rev. Econ. Stat.
**78**, 1–15 (1996)CrossRefGoogle Scholar - Debreu, G.: Theory of Value. Yale University Press, New Haven (1959)Google Scholar
- Dubey, P., Geanakoplos, J., Shubik, M.: Default and punishment in a general equilibrium model with incomplete markets. Econometrica
**73**, 1–37 (2005)CrossRefGoogle Scholar - Dubey, P., Geanakoplos, J., Zame, W.R.: Collateral, Default and Market Crashes. Cowles Foundation Discussion Paper (1995)Google Scholar
- Duffie, D., Shafer, W.: Equilibrium in incomplete markets, I: a basic model of generic existence. J. Math. Econ.
**14**, 285–300 (1985)CrossRefGoogle Scholar - Duffie, D., Shafer, W.: Equilibrium in incomplete markets, II: generic existence in stochastic economies. J. Math. Econ.
**15**, 199–216 (1986)CrossRefGoogle Scholar - Elul, R.: Effectively complete equilibria—a note. J. Math. Econ.
**32**, 113–119 (1999)CrossRefGoogle Scholar - Fay, S., Hurst, E., White, M.: The household bankruptcy decision. Am. Econ. Rev.
**92**, 706–718 (2002)CrossRefGoogle Scholar - Fostel, A., Geanakoplos, J.: Leverage cycles and the anxious economy. Am. Econ. Rev.
**98**, 1211–1244 (2008)CrossRefGoogle Scholar - Fostel, A., Geanakoplos, J.: CDS and asset prices: how financial innovation can cause bubbles and crashes. Am. Econ. J. Macroecon.
**4**, 190–225 (2012)CrossRefGoogle Scholar - Fostel, A., Geanakoplos, J.: Leverage and Default in Binomial Economies: A Complete Characterization. Cowles Foundation Working Paper (2013a)Google Scholar
- Fostel, A., Geanakoplos, J.: Financial Innovation, Collateral and Investment. Cowles Foundation Working Paper (2013b)Google Scholar
- Garleanu, N., Pedersen, L.: Margin-based asset pricing and the law of one price. Rev. Financ. Stud.
**24**, 1980–2022 (2011)CrossRefGoogle Scholar - Geanakoplos, J.: Promises, promises. In: Arthur, W.B., et al. (eds.) The Economy as an Evolving Complex System, II. Addison-Wesley, Reading, MA (1997)Google Scholar
- Geanakoplos, J., Zame, W.R.: Collateral and the enforcement of intertemporal contracts. Cowles Foundation Working Paper (1997)Google Scholar
- Geanakoplos, J., Zame, W.R.: Collateralized security markets. Cowles Foundation Working Paper (2002)Google Scholar
- Geanakoplos, J.: Liquidity, default and crashes: endogenous contracts in general equilibrium. In: Eighth World Econometric Society Conference, vol. II, pp. 170–205. Econometric Society Monographs (2003)Google Scholar
- Geanakoplos, J., Zame, W.R.: Collateral equilibrium, II: securitization and efficiency. Discussion paper, UCLA (2013)Google Scholar
- Girardi, K., Shapiro, A., Willen, P.: Subprime outcomes: risky mortgages, homeownership experiences, and foreclosures. Federal Reserve Bank of Boston Working Paper (2008)Google Scholar
- Grill, M., Schmedders, K., Kubler, F., Brumm, J.: Collateral requirements and asset prices. Meeting Papers 737, Society for Economic, Dynamics (2011)Google Scholar
- Hart, O.: On the optimality of equilibrium when the market structure is incomplete. J. Econ. Theory
**11**, 418–443 (1975)CrossRefGoogle Scholar - Hellwig, M.F.: Bankruptcy, limited liability and the Modigliani–Miller theorem. Am. Econ. Rev.
**72**, 155–170 (1981)Google Scholar - Hernandez, A., Santos, M.: Competitive equilibria for infinite-horizon economies with incomplete markets. J. Econ. Theory
**71**, 102–130 (1996)Google Scholar - Hindy, A.: Viable prices in financial markets with solvency constraints. J. Math. Econ.
**24**, 105–135 (1994)CrossRefGoogle Scholar - Holmstrom, B., Tirole, J.: Financial intermediation, loanable funds and the real sector. Q. J. Econ.
**112**, 663–692 (1997)CrossRefGoogle Scholar - Kau, J., Keenan, D., Kim, T.: Default probabilities for Mortgages. J. Urban Econ.
**35**, 278–296 (1994)CrossRefGoogle Scholar - Kehoe, T., Levine, D.K.: Debt constrained asset markets. Rev. Econ. Stud.
**60**, 865–888 (1993)CrossRefGoogle Scholar - Kilenthong, W.T.: Collateral premia and risk sharing under limited commitment. Econ. Theory
**46**, 475–501 (2011)CrossRefGoogle Scholar - Kiyotaki, N., Moore, J.: Credit cycles. J. Polit. Econ.
**105**, 211–248 (1997)CrossRefGoogle Scholar - Ku, A., Polemarchakis, H.: Options and equilibrium. J. Math. Econ.
**19**, 107–112 (1990)CrossRefGoogle Scholar - Lagos, R.: Asset prices and liquidity in an exchange economy. J. Monet. Econ.
**57**, 913–930 (2010)CrossRefGoogle Scholar - Levine, D.K., Zame, W.R.: Debt constraints and equilibrium in infinite horizon economies with incomplete markets. J. Math. Econ.
**26**, 103–131 (1996)Google Scholar - Lin, E., White, M.: Bankruptcy and the market for mortgage and home improvement loans. J. Urban Econ.
**50**, 138–162 (2001)CrossRefGoogle Scholar - Lustig, H., Nieuwerburgh, S.V.: Housing collateral, consumption insurance and risk premia: an empirical perspective. J. Finance
**60**, 1167–1219 (2005)CrossRefGoogle Scholar - Magill, M., Quinzii, M.: Infinite horizon incomplete markets. Econometrica
**62**, 853–880 (1994)Google Scholar - Mankiw, G., Weil, D.: The baby boom, the baby bust, and the housing market. Reg. Sci. Urban Econ.
**19**, 235–258 (1989)CrossRefGoogle Scholar - Sabarwal, T.: Competitive equilibria with incomplete markets and endogenous bankruptcy. Contrib. Theor. Econ.
**3**(2003)Google Scholar - Simsek, A.: Belief disagreements and collateral constraints. Econometrica
**81**, 1–53 (2013)CrossRefGoogle Scholar - Steinert, M., Torres-Martinez, J.P.: General equilibrium in CLO markets. J. Math. Econ.
**43**, 709–734 (2007)CrossRefGoogle Scholar - Zame, W.R.: Efficiency and the role of default when security markets are incomplete. Am. Econ. Rev.
**83**, 1142–1164 (1993)Google Scholar

## Copyright information

© Springer-Verlag Berlin Heidelberg 2013