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Debt Financing in Asset Markets

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  • Zhiguo He
  • Wei Xiong

Abstract

We study rollover risk and collateral value in a dynamic asset pricing model with endogenous debt financing by extending the framework of Geanakoplos (2009) with a generic binomial tree and time-varying heterogeneous beliefs. Optimistic borrowers face rollover risk if the belief dispersion between the borrowers and the pessimistic lenders widens after interim bad news. We demonstrate the optimality of the maximum riskless short-term debt financing for optimistic borrowers even in the presence of the rollover risk. We also highlight the role of interim trading which, by allowing creditors to sell seized collateral to other optimists with saved cashes, boosts the asset’s collateral value and equilibrium price.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17935.

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Date of creation: Mar 2012
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Publication status: published as Zhiguo He & Wei Xiong, 2012. "Debt Financing in Asset Markets," American Economic Review, American Economic Association, vol. 102(3), pages 88-94, May.
Handle: RePEc:nbr:nberwo:17935

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  1. John Geanakoplos, 2010. "The Leverage Cycle," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 1-65 National Bureau of Economic Research, Inc.
  2. Wei Xiong & Zhiguo He, 2010. "Rollover Risk and Credit Risk," 2010 Meeting Papers 98, Society for Economic Dynamics.
  3. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  4. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
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