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Imperfect Knowledge About Asset Prices and Credit Cycles

Pei Kuang

Discussion Papers from Department of Economics, University of Birmingham

Abstract: This paper develops an equilibrium model with a housing collateral constraint in which rational agents are uncertain about the collateral price process. Bayesian learning by agents can endogenously generate booms and busts in collateral prices and significantly strengthen the role of the collateral constraint as an amplification mechanism through the interaction of agents' price beliefs, price realizations and credit limits. Over-optimism or pessimism is fueled when a surprise in price expectations is interpreted partially by the agents as a permanent change in the parameters governing the collateral price process and is validated by subsequently realized prices. The learning model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. The paper also demonstrates that the leveraged economy with a higher steady state leverage ratio is more prone to self-inforcing learning dynamics.

Keywords: Boom-Bust; Collateral Constraints; Learning; Leverage; Housing (search for similar items in EconPapers)
JEL-codes: D83 D84 E32 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta and nep-dge
Date: 2013-11
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Persistent link: https://EconPapers.repec.org/RePEc:bir:birmec:13-02

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