Sequential costly state verifications under two-state Markov chain shocks.

摘要

This paper studies sequential costly state verification as a formal representation of loan-default negotiation in an infinite horizon principal-agent model with privately observed two-state first-order Markov income shocks. The main result is as follows: With some particular parametric assumptions, there exists a trade equilibrium where costly state verifications occur recurrently only when lender believes that high state is probable while borrower knows that the true state is low. In the trade equilibrium, default plays a positive role in ex ante contingent agreement. Also, as an application to international finance, this paper gives some insights into autarkic-financing features in the world's poorest economies.