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Endogenous Borrowing Constraints With Incomplete Markets

Authors

  • HAROLD H. ZHANG

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    • Carnegie Mellon University. I thank Ravi Bansal, John Coleman, Chandra Das, Ronald Gallant, Uday Rajan, Bryan Routledge, Thomas Tallarini, George Tauchen, Chris Telmer, seminar participants at Carnegie Mellon University and Duke University, René Stulz, the editor, and an anonymous referee for helpful comments and suggestions. The article was presented at the 1996 annual meetings of Society for Economic Dynamics and Control in Mexico City. All remaining errors are mine.


ABSTRACT

This article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models. We allow the constraints to depend on an investor's characteristics such as time preference, risk aversion, and income streams. The proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default. Using a numerical algorithm, we find that for an array of structural parameters, the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies.

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