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Imperfect Knowledge About Asset Prices and Credit Cycles

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  • Pei Kuang

Abstract

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.

Suggested Citation

  • Pei Kuang, 2013. "Imperfect Knowledge About Asset Prices and Credit Cycles," Discussion Papers 13-02r, Department of Economics, University of Birmingham.
  • Handle: RePEc:bir:birmec:13-02r
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    File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/13-02R.pdf
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    References listed on IDEAS

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    1. Klaus Adam & Pei Kuang & Albert Marcet, 2012. "House Price Booms and the Current Account," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 77-122.
    2. KevinX.D. Huang & Zheng Liu & Tao Zha, 2009. "Learning, Adaptive Expectations and Technology Shocks," Economic Journal, Royal Economic Society, vol. 119(536), pages 377-405, March.
    3. Andrea Ferrero, 2011. "House Prices Booms and Current Account Deficits," 2011 Meeting Papers 1386, Society for Economic Dynamics.
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    6. 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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    8. 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.
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    13. 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.
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    Cited by:

    1. Kuang, Pei, 2016. "A Note On Learning In A Credit Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 20(03), pages 845-855, April.

    More about this item

    Keywords

    Boom-Bust; Collateral Constraints; Learning; Leverage; Housing;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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