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Endogenous Leverage and Default in the Laboratory

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  • Marco Cipriani
  • Ana Fostel
  • Daniel Houser

Abstract

We study default and endogenous leverage in the laboratory. To this purpose, we develop a general equilibrium model of collateralized borrowing amenable to laboratory implementation and gather experimental data. In the model, leverage is endogenous: agents choose how much to borrow using a risky asset as collateral, and there are no ad hoc collateral constraints. When the risky asset is financial?namely, its payoff does not depend on ownership (such as a bond)? collateral requirements are high and there is no default. In contrast, when the risky asset is nonfinancial?namely, its payoff depends on ownership (such as a firm)?collateral requirements are lower and default occurs. The experimental outcomes are in line with the theory's main predictions. The type of collateral, whether financial or not, matters. Default rates and loss from default are higher when the risky asset is nonfinancial, stemming from laxer collateral requirements. Default rates and collateral requirements move closer to the theoretical predictions as the experiment progresses.

Suggested Citation

  • Marco Cipriani & Ana Fostel & Daniel Houser, 2019. "Endogenous Leverage and Default in the Laboratory," Staff Reports 900, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:900
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    References listed on IDEAS

    as
    1. Ana Fostel & John Geanakoplos, 2012. "Leverage and Default in Binomial Economies: A Complete Characterization," Cowles Foundation Discussion Papers 1877RRR, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
    2. Ana Fostel & John Geanakoplos, 2014. "Endogenous Collateral Constraints and the Leverage Cycle," Annual Review of Economics, Annual Reviews, vol. 6(1), pages 771-799, August.
    3. Plott, Charles R., 2008. "Properties of Disequilibrium Adjustment in Double Auction Markets," Handbook of Experimental Economics Results, in: Charles R. Plott & Vernon L. Smith (ed.), Handbook of Experimental Economics Results, edition 1, volume 1, chapter 1, pages 16-21, Elsevier.
    4. Bossaerts, Peter & Plott, Charles R., 2008. "From Market Jaws to the Newton Method: The Geometry of How a Market Can Solve Systems of Equations," Handbook of Experimental Economics Results, in: Charles R. Plott & Vernon L. Smith (ed.), Handbook of Experimental Economics Results, edition 1, volume 1, chapter 2, pages 22-24, Elsevier.
    5. Elena Asparouhova, 2006. "Competition in Lending: Theory and Experiments," Review of Finance, European Finance Association, vol. 10(2), pages 189-219.
    6. Cooper, David J., 2014. "A Note on Deception in Economic Experiments," Journal of Wine Economics, Cambridge University Press, vol. 9(02), pages 111-114, August.
    7. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-1244, September.
    8. Ana Fostel & John Geanakoplos, 2012. "Leverage and Default in Binomial Economies: A Complete Characterization," Cowles Foundation Discussion Papers 1877R3, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
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    More about this item

    Keywords

    collateral; default; double auction; experimental economics; leverage;
    All these keywords.

    JEL classification:

    • A10 - General Economics and Teaching - - General Economics - - - General
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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