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
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Citations: View citations in EconPapers (79)

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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)
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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

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