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Imperfect Knowledge about Asset Prices and Credit Cycles

  • Pei Kuang

    ()

    (University of Birmingham)

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    I develop an equilibrium model with collateral constraints in which rational agents are uncertain and learn about the equilibrium mapping between fundamentals and collateral prices. Bayesian updating of beliefs by agents can endogenously generate booms and busts in collateral prices and largely strengthen the role of collateral constraints as an amplification mechanism through the interaction of agents?' beliefs, collateral prices 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. I show that the model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. I also demonstrate that the leveraged economy with a higher steady state leverage ratio is more prone to self-reinforcing learning dynamics.

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    File URL: http://www.st-andrews.ac.uk/economics/repecfiles/2/1303.pdf
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    Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201303.

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    Date of creation: 01 Jan 2013
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    Handle: RePEc:san:cdmawp:1303
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    5. Cordoba, Juan & Ripoll, Marla, 2002. "Credit Cycles Redux," Working Papers 2002-07, Rice University, Department of Economics.
      • Juan-Carlos Cordoba & Marla Ripoll, 2004. "Credit Cycles Redux," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1011-1046, November.
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    15. Kevin X.D. Huang & Zheng Liu & Tao Zha, 2008. "Learning, Adaptive Expectations, and Technology Shocks," Vanderbilt University Department of Economics Working Papers 0807, Vanderbilt University Department of Economics.
    16. Simeon Djankov & Oliver Hart & Caralee McLiesh & Andrei Shleifer, 2006. "Debt Enforcement Around the World," NBER Working Papers 12807, National Bureau of Economic Research, Inc.
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    18. Milani, Fabio, 2010. "Expectation Shocks and Learning as Drivers of the Business Cycle," CEPR Discussion Papers 7743, C.E.P.R. Discussion Papers.
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    21. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
    22. Pei Kuang, 2013. "A Note on Learning in a Credit Economy," Discussion Papers 14-08, Department of Economics, University of Birmingham.
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