Financial Innovation, Collateral and Investment

Ana Fostel and John Geanakoplos ()
Additional contact information
Ana Fostel: Dept. of Economics, George Washington University
John Geanakoplos: Cowles Foundation, Yale University, https://economics.yale.edu/people/faculty/john-geanakoplos

No 1903R, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: Financial innovations that change how promises are collateralized can affect investment, even in the absence of any change in fundamentals. In C-models, the ability to leverage an asset always generates over-investment compared to Arrow Debreu. The introduction of CDS always leads to under-investment with respect to Arrow Debreu, and in some cases even robustly destroys competitive equilibrium. The need for collateral would seem to cause under-investment. Our analysis illustrates a countervailing force: goods that serve as collateral yield additional services and are therefore over-valued and over-produced. In models without cash flow problems there is never marginal under-investment on collateral.

Keywords: Financial innovation; Collateral; Investment; Repayment enforceability problems; Cash flow problems; Leverage; CDS; Non-existence; Marginal efficiency (search for similar items in EconPapers)
JEL-codes: D52 D53 E44 G01 G11 G12 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2013-07, Revised 2015-03
New Economics Papers: this item is included in nep-ban and nep-mac
Note: See CFP 1510
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published in American Economic Journal: Macroeconomics (January 2016), 8(1): 242-284

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