Financial innovation, the discovery of risk, and the U.S. credit crisis

Emine Boz and Enrique Mendoza

Journal of Monetary Economics, 2014, vol. 62, issue C, 1-22

Abstract: Financial innovation and overconfidence about the risk of new financial products were key factors behind the 2008 U.S. credit crisis. We show that a model with a collateral constraint in which learning about the risk of a new financial environment interacts with Fisherian amplification produces a boom–bust cycle in debt, asset prices and consumption. Early realizations of a high-borrowing-ability regime turn agents optimistic about the persistence probability of this regime. Conversely, the first realization of a low-borrowing-ability regime turns agents unduly pessimistic. The model predicts large increases in household debt, land prices and excess returns during 1998–2006 followed by a collapse.

Keywords: Credit crisis; Financial innovation; Imperfect information; Learning; Asset prices; Fisherian amplification; Anticipated utility (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (78)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304393213001062
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis (2010)
Working Paper: Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis (2010)
Working Paper: Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis (2010)
Working Paper: Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis (2010)
Working Paper: Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis (2009)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:62:y:2014:i:c:p:1-22

DOI: 10.1016/j.jmoneco.2013.07.001

Access Statistics for this article

Journal of Monetary Economics is currently edited by R. G. King and C. I. Plosser

More articles in Journal of Monetary Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().