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Full-Text Articles in Social and Behavioral Sciences
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become more volatile in bad times. Agents choose these technologies because they can be leveraged more during normal times. Together …
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become more volatile in bad times. Agents choose these technologies because they can be leveraged more during normal times. Together …
Solving The Present Crisis And Managing The Leverage Cycle, John Geanakoplos
Solving The Present Crisis And Managing The Leverage Cycle, John Geanakoplos
Cowles Foundation Discussion Papers
The present crisis is the bottom of a recurring problem that I call the leverage cycle, in which leverage gradually rises too high then suddenly falls much too low. The government must manage the leverage cycle in normal times by monitoring and regulating leverage to keep it from getting too high. In the crisis stage the government must stem the scary bad news that brought on the crisis, which often will entail coordinated write downs of principal; it must restore sane leverage by going around the banks and lending at lower collateral rates (not lower interest rates), and when necessary …