Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral.First, our Binomial No-Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no default.Thus actual default is irrelevant, though the potential for default drives the equilibrium and limits borrowing.This result is valid with arbitrary preferences and endowments, arbitrary promises, many assets and consumption goods, production, and multiple periods.We also show that the no-default equilibrium would be selected if there were the slightest cost of using collateral or handling default.Second, our Binomial Leverage Theorem shows that equilibrium LT V for non-contingent debt contracts is the ratio of the worst-case return of the asset to the riskless rate of interest.Finally, our Binomial Leverage-Volatility theorem provides a precise link between leverage and volatility.

We provide a pricing theory for emerging asset classes, like emerging markets, that are not yet mature enough to be attractive to the general public. We show how leverage cycles can cause contagion, flight to collateral, and issuance rationing in a frequently recurring phase we call the anxious economy. Our model provides an explanation for the volatile access of emerging economies to international financial markets, and for three stylized facts we identify in emerging markets and high yield data since the late 1990s. Our analytical framework is a general equilibrium model with heterogeneous agents, incomplete markets, and endogenous collateral, plus an extension encompassing adverse selection. (JEL D53, G12, G14, G15)

ABSTRACT We test the asset pricing implications of collateralized borrowing (that is, of using assets as collateral to borrow money) in the laboratory. To this purpose, we develop a general equilibrium model with collateral constraints amenable to laboratory implementation and gather experimental data. In the laboratory, assets that can be leveraged fetch higher prices than assets that cannot, even though assets' payoffs are identical in all states of the world. Collateral value, therefore, creates deviations from the Law of One Price. The spread between collateralizeable and noncollateralizeable assets is significant and quantitatively close to theoretical predictions.