Financial Innovation, Collateral, and Investment

Ana Fostel and John Geanakoplos

American Economic Journal: Macroeconomics, 2016, vol. 8, issue 1, 242-84

Abstract: Financial innovations that change how promises are collateralized affect prices and investment, even in the absence of any change in fundamentals. In C-models, the ability to leverage an asset always generates overinvestment compared to Arrow-Debreu. Credit Default Swaps always leads to underinvestment with respect to Arrow-Debreu, and in some cases even robustly destroy competitive equilibrium. The need for collateral would seem to cause underinvestment. Our analysis illustrates a countervailing force: goods that serve as collateral yield additional services and can therefore be over-valued and over-produced. In models without cash flow problems there is never marginal underinvestment on collateral. (JEL D52, D86, D92, E44, G01, G12, R31)

JEL-codes: D52 D86 D92 E44 G01 G12 R31 (search for similar items in EconPapers)
Date: 2016
Note: DOI: 10.1257/mac.20130183
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Citations: View citations in EconPapers (16)

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