A Costly State Verification Model with Diversity of Opinions
Title: A Costly State Verification Model with Diversity of Opinions
Citation: Economic Theory, 2005, 25, 2, 497-504
In simple models of borrowing and lending with ex-post asymmetric information, Gale and Hellwig (1985) and Williamson (1986) have shown that optimal debt contracts are simple debt contracts where borrowers repay a fixed interest rate whenever possible and lenders seize all the profit when borrowers default. In this note, we depart from their works by assuming that borrowers and lenders have heterogeneous beliefs, and show that simple debt contracts do not necessarily survive as optimal contracts.
Subject: costly state verification; heterogeneity of beliefs
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