Trees as secured loan collateral: a case study in the BAAC tree bank program

This study presents a theoretical model of collateral-secured loans with three assets: money, capital, and Lucas trees—where the capital goods are the conventional collateral and the Lucas tree is the new additional asset to serve as a guarantee of loan repayments. The study indicates that the positive liquidity premium of Lucas trees arises from its role of collateral generating liquidity, which lifts the price of the asset to be above its fundamental value. In the steady state equilibrium where both capital and Lucas trees served as collateral, higher levels of collateral accumulation relax the borrowing constraint; its tightness depends on the marginal productivity of capital, the returns of Lucas trees, and the liquidity premiums of collateral assets which respond to the rate of inflation and the relative risk aversion of agents to determine the corresponding behavior of asset accumulations. In search of this insightful collateral mechanism, the model can capture the tree collateral of the BAAC Tree Bank program case study. In addition, this study considers some complicated realities of tree collateral challenging lenders and the existent risk mitigation of the BAAC Tree Bank Program.