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Financial crises with different collateral types

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  • Shah, Rohan

Abstract

Firms borrow against earnings more than they do against their assets. How does this affect the aggregate response to financial crises? I take a dynamic stochastic general equilibrium model of heterogeneous firms that choose their capital and debt subject to a borrowing constraint and examine the recovery from a financial crisis when firms can use different types of collateral. I compare between two collateral types: assets, and earnings. I find that when firms borrow against earnings recessions are deeper, but recoveries are quicker compared to when firms borrow against assets. I also find that neither type of collateral can, by itself, completely explain the recovery from the Great Recession. Instead, the path of investment after the 2007-2008 Financial crisis is better captured by firms borrowing against earnings than by firms borrowing against assets, but this is reversed when looking at the path of output. This suggests that a combination of collateral types is required to fully capture the recovery from the Great Recession.

Suggested Citation

  • Shah, Rohan, 2024. "Financial crises with different collateral types," Journal of Economic Dynamics and Control, Elsevier, vol. 166(C).
    • Handle: RePEc:eee:dyncon:v:166:y:2024:i:c:s0165188924001076
    DOI: 10.1016/j.jedc.2024.104915
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    References listed on IDEAS

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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