MS&E 147 Chapter Notes - Chapter 3: Downside Risk, Flood Insurance

• School: Stanford University
• Department: MS&E - Mgmt Science & Engineering
• Course: MS&E 147
• Professor: Anat Admati

Document Summary

Defaulting on debts: disruptive and many consequences. As borrower, want creditors to think it is temporary liquidity problem, no cash to pay today but will able to pay later. Not want solvency to be in doubt - the ability to eventually pay debts. If there is no hope in paying debts but creditors keep letting kate borrow, kate will be reckless and gamble for resurrection. Taking best because there is nothing to lose mentality. Impact of debt felt before borrower defaults - borrowers make different decisions and perverse incentives compel them to do so. If kate loses job, mortgage payments burden, might take additional loan, but then interest increases a lot. Greater risk to kate if interest rate on mortgage was adjustable rate mortgages. Risks of borrowing for businesses larger than individuals. When borrower defaults, lender usually waits to see if payment late. Going to court to collect debts and take collateral is costly.