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Asset Holdings, Information Aggregation in Secondary Markets and Credit Cycles

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  • Henrique S. Basso

    (Banco de España)

Abstract

Imperfect information aggregation in secondary credit markets has significant consequences for economic cycles. As banks put more weight on mark-to-market gains, they find it optimal to refrain from revealing information about adverse shocks. Consequently, default risk is mispriced, and loan volumes, and thus investment, are not appropriately reduced. Overinvestment lowers the price of capital, leading households to increase consumption without decreasing labour supply, generating a boom. Due to mispricing, banks subsequently face bigger losses and capital depletion. Output then decreases sharply due to credit supply shortages. In a model calibrated to the US economy, these instances of market dysfunction are crucial in amplifying credit cycles.

Suggested Citation

  • Henrique S. Basso, 2022. "Asset Holdings, Information Aggregation in Secondary Markets and Credit Cycles," Working Papers 2214, Banco de España.
    • Handle: RePEc:bde:wpaper:2214
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    More about this item

    Keywords

    information revelation; credit markets; mark-to-market; mispricing; bank compensation;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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