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Imperfect Knowledge About Asset Prices and Credit Cycles

  • Pei Kuang
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    This paper develops an equilibrium model with a housing collateral constraint in which rational agents are uncertain about the collateral price process. Bayesian learning by agents can endogenously generate booms and busts in collateral prices and significantly strengthen the role of the collateral constraint as an amplification mechanism through the interaction of agents' price beliefs, price realizations 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. The learning model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. The paper also demonstrates that the leveraged economy with a higher steady state leverage ratio is more prone to self-inforcing learning dynamics.

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

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    Length: 52 pages
    Date of creation: Nov 2013
    Date of revision:
    Handle: RePEc:bir:birmec:13-02r
    Contact details of provider: Postal: Edgbaston, Birmingham, B15 2TT
    Web page: http://www.economics.bham.ac.uk
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    1. KevinJ. Lansing, 2010. "Rational and Near-Rational Bubbles Without Drift," Economic Journal, Royal Economic Society, vol. 120(549), pages 1149-1174, December.
    2. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2008. "Learning, Adaptive Expectations, and Technology Shocks," Emory Economics 0803, Department of Economics, Emory University (Atlanta).
    3. Oliver Hart & John Moore, 1991. "A Theory of Debt Based on the Inalienability of Human Capital," STICERD - Theoretical Economics Paper Series /1991/233, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
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    5. 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.
    6. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
    7. Stefano Eusepi & Bruce Preston, 2008. "Expectations, Learning and Business Cycle Fluctuations," NBER Working Papers 14181, National Bureau of Economic Research, Inc.
    8. 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.
    9. Paolo Gelain & Kevin J. Lansing & Caterina Mendicino, 2013. "House Prices, Credit Growth, and Excess Volatility: Implications for Monetary and Macroprudential Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 9(2), pages 219-276, June.
    10. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2013. "Stock Market Volatility and Learning," Working Papers 336, Barcelona Graduate School of Economics.
    11. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, vol. 124(4), pages 1449-1496, November.
    12. 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.
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    14. 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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    16. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
    17. Eva Carceles-Poveda & Chryssi Giannitsarou, 2008. "Asset Pricing with Adaptive Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 629-651, July.
    18. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2013. "Household leveraging and deleveraging," Staff Reports 602, Federal Reserve Bank of New York.
    19. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
    20. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
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    22. 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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