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Asset-Price Collapse and Market Disruption - A model of financial crises -

Keiichiro Kobayashi

Discussion papers from Research Institute of Economy, Trade and Industry (RIETI)

Abstract: We construct a search-theoretic model à la Lagos and Wright (2005), that has multiple steady-state equilibria, one of which may be interpreted as a state of financial crisis. The key ingredient is the collateral-secured loan in the decentralized matching market, in which the borrowers must put up their own land as collateral. They borrow debt for intertemporal smoothing of the consumption stream and also for factor payment in production. In the crisis state, the land price is low and the debt for factor payment, i.e., liquidity, dries up. Facing a liquidity shortage, all sellers choose not to participate in the matching market and the market is shut down due to the search externality. This market disruption lowers the aggregate productivity, while the low productivity justifies the low asset price in turn. We may be able to derive a policy implication that collective debt reduction by government intervention may solve the coordination failure and bring the economy out of the crisis equilibrium.

Pages: 34 pages
Date: 2009-09
New Economics Papers: this item is included in nep-dge and nep-mac
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