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Imperfect Knowledge About Asset Prices and Credit Cycles

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  • Pei Kuang
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    Abstract

    This paper develops an equilibrium model with a housing collateral constraint in which rational agents are uncertain about the collateral price process. Bayesian learning by agents can endogenously generate booms and busts in collateral prices and significantly strengthen the role of the collateral constraint as an amplification mechanism through the interaction of agents' price beliefs, price realizations 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. The learning model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. The paper also demonstrates that the leveraged economy with a higher steady state leverage ratio is more prone to self-inforcing learning dynamics.

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    File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/13-02R.pdf
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    Bibliographic Info

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

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    Length: 52 pages
    Date of creation: Nov 2013
    Date of revision:
    Handle: RePEc:bir:birmec:13-02r

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    Postal: Edgbaston, Birmingham, B15 2TT
    Web page: http://www.economics.bham.ac.uk
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    Keywords: Boom-Bust; Collateral Constraints; Learning; Leverage; Housing;

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    1. Adam, Klaus & Marcet, Albert, 2011. "Internal rationality, imperfect market knowledge and asset prices," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1224-1252, May.
    2. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
    3. William A. Branch & George W. Evans, . "Learning about Risk and Return: A Simple Model of Bubbles and Crashes," CDMA Working Paper Series 201010, Centre for Dynamic Macroeconomic Analysis, revised 15 Apr 2010.
    4. Klaus Adam & Pei Kuang & Albert Marcet, 2011. "House Price Booms and the Current Account," NBER Working Papers 17224, National Bureau of Economic Research, Inc.
    5. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2008. "Learning, Adaptive Expectations, and Technology Shocks," Emory Economics 0803, Department of Economics, Emory University (Atlanta).
    6. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
    7. Paolo Gelain & Kevin J. Lansing & Caterina Mendicino, 2012. "House prices, credit growth, and excess volatility: implications for monetary and macroprudential policy," Working Paper Series 2012-11, Federal Reserve Bank of San Francisco.
    8. Juan Cordoba & Marla Ripoll, 2002. "Credit Cycles Redux," Macroeconomics 0210004, EconWPA.
      • 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.
    9. Justiniano, Alejandro & Primiceri, Giorgio E & Tambalotti, Andrea, 2013. "Household Leveraging and Deleveraging," CEPR Discussion Papers 9671, C.E.P.R. Discussion Papers.
    10. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
    11. KevinJ. Lansing, 2010. "Rational and Near-Rational Bubbles Without Drift," Economic Journal, Royal Economic Society, vol. 120(549), pages 1149-1174, December.
    12. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2011. "Stock Market Volatility and Learning," CEP Discussion Papers dp1077, Centre for Economic Performance, LSE.
    13. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, vol. 124(4), pages 1449-1496, November.
    14. John Y. Campbell, 1992. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," NBER Working Papers 4188, National Bureau of Economic Research, Inc.
    15. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 23 Oct 2009.
    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. Shleifer, Andrei & McLiesh, Caralee & Hart, Oliver & Djankov, Simeon, 2008. "Debt Enforcement Around the World," Scholarly Articles 2961825, Harvard University Department of Economics.
    18. Oliver Hart & John Moore, 1991. "A Theory of Debt Based on the Inalienability of Human Capital," NBER Working Papers 3906, National Bureau of Economic Research, Inc.
    19. 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.
    20. Klaus Adam & Albert Marcet, 2011. "Booms and Busts in Asset Prices," CEP Discussion Papers dp1059, Centre for Economic Performance, LSE.
    21. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
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