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Financial contracting with enforcement externalities.

Contract enforceability in financial markets often depends on the aggregate actions of agents. For example, high default rates in credit markets can delay legal enforcement or reduce the value of collateral, incentivizing even more defaults and potentially affecting credit supply. The authors develop a theory of credit provision in which enforceability of individual contracts is linked to aggregate behavior. The central element behind this link is enforcement capacity, which is endogenously determined by investments in enforcement infrastructure. This paper sheds new light on the emergence of credit crunches and the relationship between enforcement infrastructure, economic growth, and political economy distortions.

Working Paper 16-01. Lukasz A. Drozd, Federal Reserve Bank of Philadelphia; Ricardo Serrano-Padial, Drexel University.

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Title Annotation:RESEARCH UPDATE
Publication:Economic Insights
Date:Mar 22, 2016
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