School of Economics

2016 Discussion papers


School of Economics Discussion Paper 16/10


Production and Endogenous Bankruptcy
under Collateral Constraints


Miguel León-Ledesma and Jaime Orrillo
University of Kent and Catholic University of Brasilia


October 2016

Abstract:

We propose an extension of the incomplete markets general equilibrium model with production to situations in which firms default. In the model, firms are assumed to be owned by a single individual whose roles as entrepreneur and consumer are anonymous. Assets are exogenously collateralised and are seized together with future output in case of defaulting. Default is thus endogenous as output determines the deliveries from the assets issued. In turn, the receipts from each asset purchased are assumed to depend on a fraction of the firm’s output. This fraction is assumed to be anonymous and is treated as given by individuals who will anticipate it, in equilibrium, as a fraction of the whole output of the economy, generating counter-cyclical default. We show that, under usual assumptions on utilities and technologies, an equilibrium always exists. We then discuss the implications of this setting for Fisher’s “separation theorem” and the irrelevance of the financial policies of the firm.

JEL Classification:
D52; C81

Keywords: General equilibrium; Incomplete markets; default; production economy


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Last Updated: 01/11/2016