Leverage bounds with default and asymmetric information

Abstract

This paper analyzes productivity and welfare losses from capital misallocation in a general equilibrium model of occupational choice and financial intermediation. It studies the effects of risk sharing with default and imperfect monitoring on the optimal allocation of resources and derives endogenous leverage bounds. Information frictions have large impact on entrepreneurs' entry and firm-size decisions due to endogenous collateral requirements derived from incentive compatible allocations. Leverage bounds derived from default and asymmetric information constraints are then used to simulate the tradeoff from a macroprudential policy aimed at mitigating the effects of unanticipated changes in information regime.