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Collateral, credit history, and the financial decelerator

  • Ronel Elul
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    The author develops a simple model in which financial imperfections can serve to stabilize aggregate fluctuations and not merely aggravate them as in much of the previous literature; the author terms this a financial decelerator. In the model agents borrow to purchase housing and secure their loans with this long-lived asset. There are two financial imperfections in this model. First, agents are unable to commit to repay their loans — that is, they can strategically default. This limits the amount that lenders are willing to offer. In addition, however, lenders are also imperfectly informed as to a borrower’s propensity to default; that is, there is adverse selection. The latter imperfection implies that default may actually occur in equilibrium, unlike in much of the previous literature. For relatively high house prices the commitment problem ensures that the equilibrium is typically characterized by a standard financial accelerator; that is, the borrowing constraints which prevent default become tighter as falling prices reduce the wealth with which agents can collateralize future loans, thereby exacerbating aggregate fluctuations. However, Elul shows that when prices are very low, agents will default, which serves as a stabilizing force; he terms this a financial decelerator. ; Also issued as Payment Cards Center Discussion Paper No. 05-14

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    Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 05-23.

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    Date of creation: 2005
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    Handle: RePEc:fip:fedpwp:05-23
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    1. Loretta J. Mester, 1993. "Why are credit card rates sticky?," Working Papers 93-16, Federal Reserve Bank of Philadelphia.
    2. Sven Rady & François Ortalo-Magné, 2001. "Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints," CESifo Working Paper Series 470, CESifo Group Munich.
    3. P. Dubey & J. Geanakoplos & M . Shubik, 2001. "Default and Punishment in General Equilibrium," Department of Economics Working Papers 01-07, Stony Brook University, Department of Economics.
    4. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
    5. Stein, Jeremy C, 1995. "Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 379-406, May.
    6. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
    7. Bacchetta, Philippe & Caminal, Ramon, 1996. "Do Capital Market Imperfections Exacerbate Output Fluctuations?," CEPR Discussion Papers 1422, C.E.P.R. Discussion Papers.
    8. Brueckner, Jan K, 2000. "Mortgage Default with Asymmetric Information," The Journal of Real Estate Finance and Economics, Springer, vol. 20(3), pages 251-74, May.
    9. Gertler, Mark, 1992. "Financial Capacity and Output Fluctuations in an Economy with Multi-period Financial Relationships," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 455-72, July.
    10. Pradeep Dubey & John Geanakoplos & Martin Shubik, 1988. "Default and Efficiency in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers 879R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1989.
    11. Allen, Franklin, 1981. "The Prevention of Default," Journal of Finance, American Finance Association, vol. 36(2), pages 271-76, May.
    12. Christopher L. House, 2002. "Adverse Selection and the Accelerator," Macroeconomics 0211015, EconWPA.
    13. Douglas W. Diamond, 1998. "Reputation Acquisition in Debt Markets," Levine's Working Paper Archive 602, David K. Levine.
    14. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    15. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
    16. Clauretie, Terrence M & Herzog, Thomas N, 1990. "The Effect of State Foreclosure Laws on Loan Losses: Evidence from the Mortgage Insurance Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(2), pages 221-33, May.
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