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Financial innovation, the discovery of risk, and the U.S. credit crisis

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  • Boz, Emine
  • Mendoza, Enrique G.

Abstract

Financial innovation and overconfidence about the risk of new financial products were key factors behind the 2008 U.S. credit crisis. We show that a model with a collateral constraint in which learning about the risk of a new financial environment interacts with Fisherian amplification produces a boom–bust cycle in debt, asset prices and consumption. Early realizations of a high-borrowing-ability regime turn agents optimistic about the persistence probability of this regime. Conversely, the first realization of a low-borrowing-ability regime turns agents unduly pessimistic. The model predicts large increases in household debt, land prices and excess returns during 1998–2006 followed by a collapse.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 62 (2014)
Issue (Month): C ()
Pages: 1-22

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Handle: RePEc:eee:moneco:v:62:y:2014:i:c:p:1-22

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Web page: http://www.elsevier.com/locate/inca/505566

Related research

Keywords: Credit crisis; Financial innovation; Imperfect information; Learning; Asset prices; Fisherian amplification; Anticipated utility;

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References

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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis
    by Christian Zimmermann in NEP-DGE blog on 2010-08-03 03:20:21
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