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Endogenous credit cycles

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Abstract

I develop an overlapping-generations framework in which changes in lending standards generate endogenous cycles. In my economy, entrepreneurs who are privately informed about the quality of their projects need to borrow funds. Intermediaries screen entrepreneurs both through the amount of investment undertaken and through the level of entrepreneurial net worth. I show that endogenous regime switches in financial contracts —from pooling to separating and vice-versa— may generate fluctuations even in the absence of exogenous shocks. When the economy is in the pooling (separating) regime, lending standards seem “lax” (“tight”) and investment is high (low). Differently from the existing literature, my model does not require entrepreneurial net worth to be counter cyclycal or inconsequential for determining aggregate investment.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 916.

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Date of creation: Nov 2004
Date of revision: Aug 2008
Handle: RePEc:upf:upfgen:916

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Endogenous cycles; financial accelerator; adverse selection; pooling equilibrium; separating equilibrium;

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  1. Pietro Reichlin & Paolo Siconolfi, 2004. "Optimal debt contracts and moral hazard along the business cycle," Economic Theory, Springer, vol. 24(1), pages 75-109, 07.
  2. Francis Longstaff & Monika Piazzesi, 2003. "Corporate Earnings and the Equity Premium," NBER Working Papers 10054, National Bureau of Economic Research, Inc.
  3. Suarez, Javier & Sussman, Oren, 1997. "Endogenous Cycles in a Stiglitz-Weiss Economy," CEPR Discussion Papers 1604, C.E.P.R. Discussion Papers.
  4. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  5. Alberto Martin, 2003. "On Rothschild-Stiglitz as competitive pooling," Economics Working Papers 917, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2006.
  6. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  8. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  9. Reichlin Pietro, 1997. "Endogenous Cycles in Competitive Models: An Overview," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 1(4), pages 1-13, January.
  10. M. Ayhan Kose & Kenneth Rogoff & Eswar Prasad & Shang-Jin Wei, 2003. "Effects of Financial Globalization on Developing Countries," IMF Occasional Papers 220, International Monetary Fund.
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Cited by:
  1. Alberto Martin, 2009. "A model of collateral, investment and adverse selection," Economics Working Papers 1136, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Alberto Martin & Filippo Taddei, 2010. "International Capital Flows and Credit Market Imperfections: a Tale of Two Frictions," Carlo Alberto Notebooks 160, Collegio Carlo Alberto, revised 2011.
  3. Brutti, Filippo, 2008. "Legal enforcement, public supply of liquidity and sovereign risk," MPRA Paper 13949, University Library of Munich, Germany.
  4. Filippo Taddei, 2013. "International Capital Flows, Financial Frictions and Welfare," 2013 Meeting Papers 1160, Society for Economic Dynamics.
  5. Hume, Michael & Sentance, Andrew, 2009. "The global credit boom: challenges for macroeconomics and policy," Discussion Papers 27, Monetary Policy Committee Unit, Bank of England.

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