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Imperfect Knowledge about Asset Prices and Credit Cycles

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  • Pei Kuang

Abstract

I develop an equilibrium model with collateral constraints in which rational agents are uncertain and learn about the equilibrium mapping between fundamentals and collateral prices. Bayesian updating of beliefs by agents can endogenously generate booms and busts in collateral prices and largely strengthen the role of colateral constraints as an amplification mechanism through the interaction of agents' beliefs, collateral prices and credit limits. Over-optimism or pessimism is fueled when a surprise in price expectations is interpreted partially by the agents as a permanent change in the parameters governing the collateral price process and is validated by subsequently realized prices. I show that the model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. I also demonstrate that the leveraged economy with a higher steady state leverage ratio is more prone to self-reinforcing learning dynamics.

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Bibliographic Info

Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 13-02.

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Length: 45 pages
Date of creation: Jan 2013
Date of revision:
Handle: RePEc:bir:birmec:13-02

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Postal: Edgbaston, Birmingham, B15 2TT
Web page: http://www.economics.bham.ac.uk
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Related research

Keywords: Booms and Busts; Collateral Constraints; Learning; Leverage;

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References

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  1. Zheng Liu & Pengfei Wang & Tao Zha, 2011. "Land-price dynamics and macroeconomic fluctuations," NBER Working Papers 17045, National Bureau of Economic Research, Inc.
  2. Tiziana Assenzay & Michele Berardi, 2008. "Learning in a Credit Economy," Centre for Growth and Business Cycle Research Discussion Paper Series 100, Economics, The Univeristy of Manchester.
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  8. Eva Carceles-Poveda & Chryssi Giannitsarou, 2008. "Asset Pricing with Adaptive Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 629-651, July.
  9. KevinJ. Lansing, 2010. "Rational and Near-Rational Bubbles Without Drift," Economic Journal, Royal Economic Society, vol. 120(549), pages 1149-1174, December.
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  14. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November.
  15. Klaus Adam & Pei Kuang & Albert Marcet, 2011. "House Price Booms and the Current Account," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 77-122 National Bureau of Economic Research, Inc.
  16. Milani, Fabio, 2010. "Expectation Shocks and Learning as Drivers of the Business Cycle," CEPR Discussion Papers 7743, C.E.P.R. Discussion Papers.
  17. Cordoba, Juan & Ripoll, Marla, 2002. "Credit Cycles Redux," Working Papers 2002-07, Rice University, Department of Economics.
    • Juan-Carlos Cordoba & Marla Ripoll, 2004. "Credit Cycles Redux," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1011-1046, November.
  18. Simeon Djankov & Oliver Hart & Caralee McLiesh & Andrei Shleifer, 2006. "Debt Enforcement Around the World," NBER Working Papers 12807, National Bureau of Economic Research, Inc.
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  20. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
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Citations

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Cited by:
  1. Pei Kuang, 2012. "Comment on Assenza and Berardi "Learning in a Credit Economy" (2009, JEDC)," Discussion Papers 13-06, Department of Economics, University of Birmingham.
  2. Patrick A. Pintus & Jacek Suda, 2013. "Learning Financial Shocks and the Great Recession," AMSE Working Papers 1333, Aix-Marseille School of Economics, Marseille, France, revised 05 Jun 2013.

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