A MODEL OF COLLATERAL: ENDOGENIZING THE BORROWING CONSTRAINT

This article presents a simple equilibrium model in which collateralized credit emerges endogenously. In a frictional world, where commitment is limited and agent's actions are not publicly observable, we show that collateral can serve as a credible device that prevents the participating parties from reneging. Our theory provides a microfoundation to justify the borrowing constraints that are widely used in the existing macroeconomic models. Using the model, we explain the payment puzzle. We also show that some assets are more suitable as collateral than others with different physical properties, for example, storable asset versus durable asset.