Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis

Enrique Mendoza and Emine Boz

No 2010/164, IMF Working Papers from International Monetary Fund

Abstract: Uncertainty about the riskiness of new financial products was an important factor behind the U.S. credit crisis. We show that a boom-bust cycle in debt, asset prices and consumption characterizes the equilibrium dynamics of a model with a collateral constraint in which agents learn "by observation" the true riskiness of a new financial environment. Early realizations of states with high ability to leverage assets into debt turn agents optimistic about the persistence of a high-leverage regime. The model accounts for 69 percent of the household debt buildup and 53 percent of the rise in housing prices during 1997-2006, predicting a collapse in 2007.

Keywords: WP; financial crisis; credit market (search for similar items in EconPapers)
Pages: 62
Date: 2010-07-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=24047 (application/pdf)

Related works:
Journal Article: Financial innovation, the discovery of risk, and the U.S. credit crisis (2014)
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:imf:imfwpa:2010/164

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().