Moral Hazards, Bankruptcy Costs, and International Financial Capital Mobility

Abstract

Using a model with moral hazard and bankruptcy costs, we show that the direction of intertemporal trade between countries depends on differences in their autarkic distributions of wealth. We also examine the consequences of redistribution policies and bail-out policies in this framework. We show that, in the presence of bankruptcy cost and capital market imperfections due to moral hazard, the very rich and the very poor do not undertake any risk and choose to be passive lenders. Only individuals whose wealth lies within an intermediate range choose to become entrepreneurs. Redistributive policies influence the supply of entrepreneurship and autarkic interest rates.