Collateralized debt as the optimal contract

In a multiple-good risk-sharing environment with ex post private informatio n, conditions are found under which collateralized debt is the optimal cont ract. The necessary and sufficient condition is that the borrower values th e collateral good more highly than does the lender; otherwise the optimal c ontract does not resemble debt. Limited collateral can give rise to an endo genous borrowing constraint, driving a further wedge between the intertempo ral marginal rates of substitution of the borrower and the lender. Journal of Economic Literature Classification Numbers: D82, G10. (C) 2001 Academic Press.