Endogenous Collateral Constraints and the Leverage Cycle

Ana Fostel () and John Geanakoplos ()
Additional contact information
Ana Fostel: Department of Economics, George Washington University, Washington, DC 20052;
John Geanakoplos: Department of Economics, Yale University, New Haven, Connecticut 06520

Annual Review of Economics, 2014, vol. 6, issue 1, 771-799

Abstract: 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, and show how it differs from a credit 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.

Keywords: collateral equilibrium; collateral value; liquidity wedge; volatility; flight to collateral; contagion; adverse selection; agent-based models (search for similar items in EconPapers)
JEL-codes: D52 D53 E3 E32 E44 G01 G11 G12 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (30)

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