Fire sales and the financial accelerator

Woon Gyu Choi and David Cook ()

Journal of Monetary Economics, 2012, vol. 59, issue 4, 336-351

Abstract: During financial turmoil, increases in risk lead to higher default, foreclosure, and fire sales. This paper introduces a costly liquidation process for foreclosed collateral and pro-cyclical recovery rates in a dynamic stochastic general equilibrium model of the financial accelerator. Links between endogenous recovery rates, risk premia, and default risk generate a liquidity spiral, magnifying financial accelerator effects. We illustrate how collateral liquidation and monetary policy alter the real impact of financial shocks operating through macro-financial linkages; and the way a government subsidy on collateral liquidity and required liquidity buffers can help dampen the liquidity spiral by shoring up recovery rates.

Date: 2012
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Working Paper: Fire Sales and the Financial Accelerator (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:59:y:2012:i:4:p:336-351

DOI: 10.1016/j.jmoneco.2012.04.001

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