Capital market imperfections are limitations that reduce the range of financial contracts that can be signed or honored.
Therefore, the possibility of default of the borrower is not a main driving force that leads to imperfect capital markets.
The main feature of financial markets that leads to imperfection is information asymmetry between borrowers and lenders.
Another reason for capital market imperfections associated with limited commitment is the ability of the borrower to renegotiate the terms of the contract ex post.
Even though the contract is signed as a secured loan, because of the enforcement costs, the lender never gets the full payment in case of default.
That is why the incentive compatibility is needed to ensure binding contracts, in imperfect capital markets.
Even if he/she is a trustworthy person and would use the funds for good investment project and able to pay back his/her debt, the lender may not lend him/her so it leads to inefficient allocation of resources.
[7] Even though it was true that every agent could borrow at the amount they were willing to, we could not have reached the efficient allocation because of the high market interest rate causing from the cost of screening and monitoring of the banks.
the most fundamental reason is the sovereign risk that causes from the lack of a supranational legal authority, capable of enforcing contracts across borders.
[10] The main results of imperfect international capital markets are similar to domestic ones: risk and insufficient level of investment.