Subprime Mortgages and Banking in a DSGE Model

Martino Ricci and Patrizio Tirelli

No 366, Working Papers from University of Milano-Bicocca, Department of Economics

Abstract: Can a DSGE model replicate the financial crisis effects without assuming unprecedented and implausibly large shocks? Starting from the assumption that the subprime crisis triggered the financial crisis, we introduce balance-sheet effects for housing market borrowers and for commercial banks in an otherwise standard DSGE model. Our crisis experiment is initiated by a shock to subprime lending risk, which is calibrated to match the observed increase in subprime delinquency rates. Due to contagion of prime borrowers and to the ensuing adverse effect on banks balance sheets, this apparently small shock is sufficient to trigger a decline in housing investment comparable to what was observed during the financial crisis. The adverse effect of subprimers risk on commercial banks' agency problem is a crucial driver of our results.

Keywords: Housing; Mortgage default; subprime risk; DSGE (search for similar items in EconPapers)
JEL-codes: E32 E44 G01 R31 (search for similar items in EconPapers)
Pages: 40
Date: 2017-06-22, Revised 2017-06-22
New Economics Papers: this item is included in nep-ban, nep-dge, nep-mac, nep-rmg and nep-ure
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Working Paper: Subprime mortgages and banking in a DSGE model (2017)
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