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Collateral Constraints and Noisy Fluctuations

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Listed author(s):
  • Jennifer La'O

    (MIT)

Abstract

Collateral constraints on firm-level investment introduce a potentially powerful two-way feedback between the financial market and the real economy. On one hand, real economic activity forms the basis for asset dividends. On the other hand, asset prices affect collateral value, which in turn determines the ability of firms to invest. In this paper I show how this two-way feedback can generate significant expectations-driven fluctuations in asset prices and macroeconomic outcomes when information is dispersed. In particular, I study the implications of this two-way feedback within a micro-founded business-cycle economy in which agents are imperfectly, and heterogeneously, informed about the underlying economic fundamentals. I then show how tighter collateral constraints mitigate the impact of productivity shocks on equilibrium output and asset prices, but amplify the impact of "noise", by which I mean common errors in expectations. Noise can thus be an important source of asset-price volatility and business-cycle fluctuations when collateral constraints are tight.

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File URL: https://economicdynamics.org/meetpapers/2010/paper_780.pdf
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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 780.

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Date of creation: 2010
Handle: RePEc:red:sed010:780
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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Cited by:

  1. Straub, Ludwig & Ulbricht, Robert, 2015. "Endogenous Uncertainty and Credit Crunches," TSE Working Papers 15-604, Toulouse School of Economics (TSE), revised 28 Mar 2017.
  2. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and "Irrational Exuberance": A Neoclassical Approach," Discussion Papers 1502, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 17-34.

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