In this paper we examine the effects of default and collateral on risk sharing. We assume that
there is a large set of assets which all promise a risk less payoff but which distinguish
themselves by their collateral requirements. In equilibrium agents default, the assets have
different payoffs, and there are as many linearly independent assets available for trade as
there are states of the world. We derive necessary and sufficient conditions for equilibria to
be Pareto-efficient in the presence of uncertainty. We explore some examples for which the …

Repercussions of default, particularly in modern economies where promises greatly exceed
physical endowments, highlight the importance of the careful design of any mechanism
which proposes to be an improvement. Whether better results may be obtained by a purely
endogenous approach or by one involving government regulation, is often a quantitative
issue. While several enforcement mechanisms may be present in an actual economy, a
major role is clearly played by collateral. In fact, the vast majority of debt is guaranteed by …