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Imperfect Knowledge about Asset Prices and Credit Cycles

  • Pei Kuang
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    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 colateral 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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    File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/13-02.pdf
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    Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 13-02.

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    Length: 45 pages
    Date of creation: Jan 2013
    Date of revision:
    Handle: RePEc:bir:birmec:13-02
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    Edgbaston, Birmingham, B15 2TT

    Web page: http://www.economics.bham.ac.uk

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    1. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Asset Pricing with Adaptive Learning," CEPR Discussion Papers 6223, C.E.P.R. Discussion Papers.
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    3. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2011. "Stock Market Volatility and Learning," CEP Discussion Papers dp1077, Centre for Economic Performance, LSE.
    4. Eva Carceles-Poveda & Chryssi Giannitsarou, 2007. "Online Appendix to Asset Pricing with Adaptive Learning," Technical Appendices carceles08, Review of Economic Dynamics.
    5. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 23 Oct 2009.
    6. Klaus Adam & Pei Kuang & Albert Marcet, 2011. "House Price Booms and the Current Account," CEP Discussion Papers dp1064, Centre for Economic Performance, LSE.
    7. Klaus Adam & Albert Marcet, 2010. "Booms and Busts in Asset Prices," IMES Discussion Paper Series 10-E-02, Institute for Monetary and Economic Studies, Bank of Japan.
    8. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
    9. Cordoba, Juan & Ripoll, Marla, 2002. "Credit Cycles Redux," Working Papers 2002-07, Rice University, Department of Economics.
      • 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.
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    12. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-72, October.
    13. Enrique G. Mendoza & Emine Boz, 2009. "Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis," 2009 Meeting Papers 1273, Society for Economic Dynamics.
    14. Kevin X. D. Huang & Zheng Liu & Tao Zha, 2008. "Learning, adaptive expectations, and technology shocks," FRB Atlanta Working Paper 2008-20, Federal Reserve Bank of Atlanta.
    15. 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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    17. Zheng Liu & Pengfei Wang & Tao Zha, 2011. "Land-price dynamics and macroeconomic fluctuations," FRB Atlanta Working Paper 2011-11, Federal Reserve Bank of Atlanta.
    18. Shleifer, Andrei & McLiesh, Caralee & Hart, Oliver & Djankov, Simeon, 2008. "Debt Enforcement Around the World," Scholarly Articles 2961825, Harvard University Department of Economics.
    19. Milani, Fabio, 2010. "Expectation Shocks and Learning as Drivers of the Business Cycle," CEPR Discussion Papers 7743, C.E.P.R. Discussion Papers.
    20. Tiziana Assenzay & Michele Berardi, 2008. "Learning in a Credit Economy," Centre for Growth and Business Cycle Research Discussion Paper Series 100, Economics, The Univeristy of Manchester.
    21. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
    22. Andrea Ferrero, 2011. "House Prices Booms and Current Account Deficits," 2011 Meeting Papers 1386, Society for Economic Dynamics.
    23. Pei Kuang, 2013. "A Note on Learning in a Credit Economy," Discussion Papers 14-08, Department of Economics, University of Birmingham.
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