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Imperfect Knowledge about Asset Prices and Credit Cycles

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  • Pei Kuang

    ()
    (University of Birmingham)

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 collateral 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 Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201303.

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Date of creation: 01 Jan 2013
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Handle: RePEc:san:cdmawp:1303

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

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References

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  1. 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.
  2. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
  3. Matteo Iacoviello & Stefano Neri, 2008. "Housing market spillovers: Evidence from an estimated DSGE model," Temi di discussione (Economic working papers) 659, Bank of Italy, Economic Research and International Relations Area.
  4. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  5. Campbell, John, 1994. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," Scholarly Articles 3196342, Harvard University Department of Economics.
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  7. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  8. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Asset Pricing with Adaptive Learning," CEPR Discussion Papers 6223, C.E.P.R. Discussion Papers.
  9. Andrea Ferrero, 2011. "House Prices Booms and Current Account Deficits," 2011 Meeting Papers 1386, Society for Economic Dynamics.
  10. Emine Boz & Enrique G. Mendoza, 2010. "Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis," NBER Working Papers 16020, National Bureau of Economic Research, Inc.
  11. Klaus Adam & Pei Kuang & Albert Marcet, 2011. "House Price Booms and the Current Account," CEP Discussion Papers dp1064, Centre for Economic Performance, LSE.
  12. Kevin X.D. Huang & Zheng Liu & Tao Zha, 2008. "Learning, Adaptive Expectations, and Technology Shocks," Vanderbilt University Department of Economics Working Papers 0807, Vanderbilt University Department of Economics.
  13. Klaus Adam & Albert Marcet, 2011. "Booms and Busts in Asset Prices," CEP Discussion Papers dp1059, Centre for Economic Performance, LSE.
  14. Kevin J. Lansing, 2007. "Rational and Near-Rational Bubbles Without Drift," 2007 Meeting Papers 970, Society for Economic Dynamics.
  15. Eva Carceles-Poveda & Chryssi Giannitsarou, 2007. "Online Appendix to Asset Pricing with Adaptive Learning," Technical Appendices carceles08, Review of Economic Dynamics.
  16. Assenza, Tiziana & Berardi, Michele, 2009. "Learning in a credit economy," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1159-1169, May.
  17. Stefano Eusepi & Bruce Preston, 2008. "Expectations, Learning and Business Cycle Fluctuations," NBER Working Papers 14181, National Bureau of Economic Research, Inc.
  18. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
  19. Simeon Djankov & Oliver Hart & Caralee McLiesh & Andrei Shleifer, 2008. "Debt Enforcement around the World," Journal of Political Economy, University of Chicago Press, vol. 116(6), pages 1105-1149, December.
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Cited by:
  1. Patrick A. Pintus & Jacek Suda, 2013. "Learning Leverage Shocks and the Great Recession," AMSE Working Papers 1333, Aix-Marseille School of Economics, Marseille, France, revised 05 Jun 2013.
  2. Patrick A. Pintus & Jacek Suda, 2014. "Learning Financial Shocks and the Great Recession," Working Papers halshs-00830480, HAL.
  3. 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.

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