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Economic Theory

, Volume 54, Issue 1, pp 153–180 | Cite as

Savings and default

  • M. Udara Peiris
  • Alexandros P. VardoulakisEmail author
Research Article

Abstract

In the presence of uninsurable idiosyncratic risk, the optimal credit contract allows for the possibility of default. In addition, the optimal contract incorporates a precautionary savings motive over and above what agents would otherwise save. When default is sufficiently high, credit markets may collapse. A regulatory requirement on the level of savings can increase risk sharing and improve welfare by increasing the gains to trade in credit exchange. Under the appropriate verifiability condition on the level of savings, an appropriate market structure, agents voluntarily increase their level of storage such that trade and welfare improve.

Keywords

Uninsurable risk Credit Default Endogenous contracts Precautionary savings 

JEL Classification

D52 D53 E21 

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Copyright information

© Springer-Verlag Berlin Heidelberg 2012

Authors and Affiliations

  1. 1.ICEFNational Research University Higher School of EconomicsMoscowRussia
  2. 2.European Central BankFrankfurt am MainGermany
  3. 3.Banque de FranceParisFrance

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