The role of limited contract enforcement in dynamic general equilibrium has been explored extensively in key papers by Eaton and Gersovitz (1981), Kehoe and Levine (1993), Kocherlakota (1996), and Kiyotaki and Moore (1997), all of which seek to explain why individual consumption, aggregate output and asset prices fluctuate more than aggregate consumption, productivity or dividends . Limited commitment has been used to investigate anomalies in asset pricing (Alvarez and Jermann (2000, 2001), Azariadis and Kaas (2007)), international business cycles (Kehoe and Perri (2002)), economic growth (Marcet and Marimon (1992)), consumption patterns and social security issues (Krueger and Perri (2005, 2006)). All these models describe environments in which a shortage of collateral rules out complete risk sharing or consumption smoothing.

One institution that improves the distribution of consumption over households is unsecured credit backed by limiting defaulters’ subsequent trading in asset markets. The literature typically assumes that an omnipotent credit authority or auctioneer excludes defaulting agents for the rest of their lives from any asset trade. Such a penalty is clearly the strongest possible punishment in the absence of collateral. It is no surprise that even the Arrow–Debreu allocation, which corresponds to perfect enforcement, can be achieved as a competitive equilibrium provided that agents are sufficiently patient or sufficiently risk averse.