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Chapter 8: Q.13 (page 236)

Why does the free-rider problem occur in the debt market?

Short Answer

Expert verified

Free riding happens when product is non-excludable. Bondholders will have opportunity to be able to ride by assuming that other bondholders are checking and implementing the legally binding terms.

Step by step solution

01

Introduction

Debt Market is a structure where the exchange of debt instruments take place. These instruments can be bonds,

02

 Explanation

A consumer who does not pay for the goods and services they consume is known as a free-rider. Free riding decreases the private motivating force to supply any non-excludable greatly.

Restricitions can possibly diminish moral hazard, but bondholders need to montior to make these restrictions effective. Bondholders will have opportunity to be able to ride assuming that others bondholders are checking whether the restrictions are being followed or not. Different bondholders will do likewise. Because of lacking assets apportioned to checking and carrying out prohibitive regulation, a free-riding problem can occur.

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