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Social and Behavioral Sciences Commons™
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Articles 1 - 11 of 11
Full-Text Articles in Social and Behavioral Sciences
Reviewing The Leverage Cycle, Ana Fostel, John Geanakoplos
Reviewing The Leverage Cycle, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We review the theory of leverage developed in collateral equilibrium models with incomplete markets. We explain how leverage tends to boost asset prices, and create bubbles. We show how leverage can be endogenously determined in equilibrium, and how it depends on volatility. We describe the dynamic feedback properties of leverage, volatility, and asset prices, in what we call the Leverage Cycle. We also describe some cross-sectional implications of multiple leverage cycles, including contagion, flight to collateral, and swings in the issuance volume of the highest quality debt. We explain the differences between the leverage cycle and the credit cycle literature. …
Financial Innovation, Collateral And Investment, Ana Fostel, John Geanakoplos
Financial Innovation, Collateral And Investment, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show that financial innovations that change the collateral capacity of assets in the economy can affect investment even in the absence of any shift in utilities, productivity, or asset payoffs. First we show that the ability to leverage an asset by selling non-contingent promises can generate over-investment compared to the Arrow-Debreu level. Second, we show that the introduction of naked CDS can generate under-investment with respect to the Arrow-Debreu level. Finally, we show that the introduction of naked CDS can robustly destroy competitive equilibrium.
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral. Our Binomial No-Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no default. Thus actual default is irrelevant, though the potential for default drives the equilibrium and limits borrowing. This result is valid with arbitrary preferences and endowments, contingent or non-contingent promises, many assets and consumption goods, production, and multiple periods. We also show that no-default equilibria would be selected if there were the slightest cost of using collateral or …
Endogenous Leverage In A Binomial Economy: The Irrelevance Of Actual Default, Ana Fostel, John Geanakoplos
Endogenous Leverage In A Binomial Economy: The Irrelevance Of Actual Default, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show that binomial economies with financial assets are an informative and tractable model to study endogenous leverage and collateral equilibrium: endogenous leverage can be highly volatile, but it is always easy to compute. The possibility of default can have a dramatic effect on equilibrium, if collateral is scarce, yet we prove the No-Default Theorem asserting that, without loss of generality, there is no default in equilibrium. Thus potential default has a dramatic effect on equilibrium, but actual default does not. This result is valid with arbitrary preferences, contingent promises, many assets and consumption goods, production, and multiple periods. On …
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral. First, our Binomial No-Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no default. Thus actual default is irrelevant, though the potential for default drives the equilibrium and limits borrowing. This result is valid with arbitrary preferences and endowments, arbitrary promises, many assets and consumption goods, production, and multiple periods. We also show that the no-default equilibrium would be selected if there were the slightest cost of using collateral or …
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Leverage And Default In Binomial Economies: A Complete Characterization, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral. Our Binomial No-Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no default. Thus actual default is irrelevant, though the potential for default drives the equilibrium and limits borrowing. This result is valid with arbitrary preferences and endowments, contingent or non-contingent promises, many assets and consumption goods, production, and multiple periods. We also show that no-default equilibria would be selected if there were the slightest cost of using collateral or …
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show how the timing of financial innovation might have contributed to the mortgage bubble and then to the crash of 2007-2009. We show why tranching and leverage first raised asset prices and why CDS lowered them afterwards. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the puzzle is that the CDS lowers the value of the underlying asset since it is equivalent to tranching cash.
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Tranching, Cds And Asset Prices: How Financial Innovation Can Cause Bubbles And Crashes, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show how the timing of financial innovation might have contributed to the mortgage boom and then to the bust of 2007-2009. We study the effect of leverage, tranching, securitization and CDS on asset prices in a general equilibrium model with collateral. We show why tranching and leverage tend to raise asset prices and why CDS tend to lower them. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the …
Endogenous Leverage: Var And Beyond, Ana Fostel, John Geanakoplos
Endogenous Leverage: Var And Beyond, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We study endogenous leverage in a general equilibrium model with incomplete markets. We prove that in any binary tree leverage emerges in equilibrium at the maximum level such that VaR = 0, so there is no default in equilibrium, provided that agents get no utility from holding the collateral. When the collateral does affect utility (as with housing) or when agents have sufficiently heterogenous beliefs over three or more states, VaR = 0 fails to hold in equilibrium. We study commonly used examples: an economy in which investors have heterogenous beliefs and a CAPM economy consisting of investors with different …
Non-Monotone Liquidity Under-Supply, Ana Fostel, John Geanakoplos
Non-Monotone Liquidity Under-Supply, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We define liquidity as the flexibility to move goods (money) from one project (investment) to another. We show that credit constraints on demand by themselves can cause an under-supply of liquidity, without the uncertainty, intermediation, asymmetric information or complicated international financial framework used in other models in the literature. In this respect liquidity is like a commodity: according to our offsetting distortions principle, a distortion in the demand for any good can often be understood as an inefficiency of supply. We show that the liquidity under-supply is a non-monotone function of the credit constraint. This result is also a particular …
Collateral Restrictions And Liquidity Under-Supply: A Simple Model, Ana Fostel, John Geanakoplos
Collateral Restrictions And Liquidity Under-Supply: A Simple Model, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
We show that very little is needed to create liquidity under-supply in equilibrium. Credit constraints on demand by themselves can cause an under-supply of liquidity, without the uncertainty, intermediation, asymmetric information or complicated international financial framework used in other models in the literature. We show that the under-supply is a non-monotone function of the demand distortion that causes it, a result that may have interesting implications for emerging markets economies. Finally, when we make the credit constraint endogenous, the inefficiency can be large due to the presence of a multiplier.