Collateral Requirements and Asset Prices

In this paper we examine the effect of collateral requirements on the prices of long- lived assets. We consider a Lucas-style infinite-horizon exchange economy with hetero- geneous agents and collateral constraints. There are two trees in the economy which can be used as collateral for short-term loans. For the first tree the collateral requirement is determined endogenously while the collateral requirement for loans on the second tree is exogenously regulated. We show that the presence of collateral constraints and the endogenous margin requirements for the first tree lead to large excess price-volatility of the second tree. Changes in the regulated margin requirements for the second tree have large effects on the volatility of both trees. While tightening margins for loans on the second tree always decreases the price volatility of the first tree, price volatility of the second tree might very well increase with this change. In our calibration we allow for the possibility of disaster states. This leads to very large quantitative effects of collateral requirements and to realistic equity risk premia. We show that our qualitative results are robust to the actual parametrization of the economy.