Dynamic Financial Constraints: Distinguishing Mechanism Design From Exogenously Incomplete Regimes

Date Added: Feb 2010
Format: PDF

The authors formulate and solve a range of dynamic models of information-constrained credit that allow for moral hazard and unobservable investment. They compare them to full insurance and exogenously incomplete financial regimes (autarky, saving only, and borrowing and lending in a single asset). They develop computational methods based on mechanism design, linear programming, and maximum likelihood to estimate, compare, and statistically test these alternative theoretical models of financial constraints. Their methods work with both cross-sectional and panel data and allow for measurement error and unobserved heterogeneity.