Collateralized Borrowing and Increasing Risk

Gregory Phelan

No 2015-03, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: This paper uses a general equilibrium model with collateralized borrowing to show that increases in risk can have ambiguous effects on leverage, loan margins, loan amounts, and asset prices. Increasing risk about future payoffs and endowments can lead to riskier loans with larger balances and lower spreads even when lenders are risk-averse and borrowers can default. As well, increasing the covariance of either agents' endowments with the asset payoff can have ambiguous consequences for equilibrium. Though the effects are ambiguous, key determinants of how increased risk translate into changes in prices and allocations are the correlation of agents' endowments with the asset payoff, agents' risk aversion, and the location of increased risk in the distribution of future states. Some restricted changes in the borrower's or lender's endowments can have unambiguous but asymmetric effects on equilibrium.

Keywords: Leverage; risk; collateral constraints; asset prices (search for similar items in EconPapers)
JEL-codes: D52 D53 G11 G12 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2015-04, Revised 2015-06
New Economics Papers: this item is included in nep-ban and nep-dge
References: View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Collateralized borrowing and increasing risk (2017)
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