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Moral hazard credit cycles with risk-averse agents

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  • Roger Myerson

    (University of Chicago)

Abstract

We consider a simple overlapping-generations model with risk-averse financial agents subject to moral hazard. Efficient contracts for such financial intermediaries involve back-loaded late-career rewards. Compared to the analogous model with risk-neutral agents, risk aversion tends to reduce the growth of agents' responsibilities over their careers. This moderation of career growth rates can reduce the amplitude of the widest credit cycles, but it also can cause small deviations from steady state to amplify over time in rational-expectations equilibria. We find equilibria in which fluctuations increase until the economy enters a boom/bust cycle where no financial agents are hired in booms.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 182.

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Date of creation: 2012
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Handle: RePEc:red:sed012:182

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