Endogenous Credit Cycles and Financial Dampening in an Adverse Selection Economy

We propose an adverse selection framework in which the financial sector has a dual role. It amplifies or dampens exogenous shocks and also generates endogenous fluctuations. We fully characterize constrained optimal contracts in a setting in which entrepreneurs need to borrow and are privately informed about the quality of their projects. Our characterization is novel in analyzing pooling and separating allocations in a context of multi-dimensional screening: specifically, the amounts of investment undertaken and of entrepreneurial net worth are used to screen projects. We then embed these results in a dynamic competitive economy. First, we show how endogenous regime switches in financial contracts may generate fluctuations in an economy that exhibits no dynamics under full information. Unlike previous models of endogenous cycles, our result does not rely on entrepreneurial net worth being counter-cyclical or inconsequential for determining investment. Secondly, the model shows the different implications of adverse selection as opposed to pure moral hazard. In particular, and contrary to standard results in the macroeconomic literature, the financial system may dampen exogenous shocks in the presence of adverse selection.

Endogenous credit cycles

I develop an overlapping-generations framework in which changes in lending standards generateendogenous cycles. In my economy, entrepreneurs who are privately informed about thequality of their projects need to borrow funds. Intermediaries screen entrepreneurs both throughthe amount of investment undertaken and through the level of entrepreneurial net worth.I show that endogenous regime switches in financial contracts from pooling to separatingand vice-versa may generate fluctuations even in the absence of exogenous shocks. Whenthe economy is in the pooling (separating) regime, lending standards seem lax ( tight ) andinvestment is high (low). Differently from the existing literature, my model does not requireentrepreneurial net worth to be counter cyclycal or inconsequential for determining aggregateinvestment.

Boundedly rational credit cycles

We propose an evolutionary model of a credit market. We show that theeconomy exhibits credit cycles. The model predicts dynamics which are consistent with some evidence about the Great Depression. Real shocks triggerepisodes of credit--crunch which are observed in the process of adjustmenttowards the post shock equilibrium.

Credit cycles in theory and experiment

We test in the laboratory the potential of evolutionary dynamics as predictor of actual behavior. To this end, we propose an asymmetricgame -which we interpret as a borrowerlender relation-, study itsevolutionary dynamics in a random matching set-up, and tests itspredictions. The model provides conditions for the existence ofcredit markets and credit cycles. The theoretical predictions seemto be good approximations of the experimental results.

Credit cycle identification: A Markov-switching application

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics

Endogenous cycles in a Stiglitz-Weiss economy

The literature on financiaI imperfections and business cycles has focused on propagation mechanisms. In this pape r we model apure reversion mechanism, such that the economy may converge to a two period equilibrium cycle. This mechanism confirms that financiaI imperfections may have a dramatic amplification effect. Unlike in some related models, contracts are complete. Indexation is not assumed away. The welfare properties of a possible stabilizing policy are analyzed. The model i tself is a dynamic extension of the well-known Stigli tz-Weiss model of lending under moral hazard. Although stylized the model still captures some important features of credit cycles.

A model of dynamic liquidity contracts

I study long-term financial contracts between lenders and borrowers in the absence of perfect enforceability and when both parties are credit constrained. Borrowers repeatedly have projects to undertake and need external financing. Lenders can commit to contractual agreements whereas borrowers can renege any period. I show that equilibrium contracts feature interesting dynamics: the economy exhibits efficient investment cycles; absence of perfect enforcement and shortage of capital skew the cycles toward states of liquidity drought; credit is rationed if either the lender has too little capital or if the borrower has too little collateral. This paper's technical contribution is its demonstration of the existence and characterization of financial contracts that are solutions to a non-convex dynamic programming problem.

De lo micro a lo macro prudencial: Un análisis de la supervisión bancaria desde la econometría espacial

La crisis que se desató en el mercado hipotecario en Estados Unidos en 2008 y que logró propagarse a lo largo de todo sistema financiero, dejó en evidencia el nivel de interconexión que actualmente existe entre las entidades del sector y sus relaciones con el sector productivo, dejando en evidencia la necesidad de identificar y caracterizar el riesgo sistémico inherente al sistema, para que de esta forma las entidades reguladoras busquen una estabilidad tanto individual, como del sistema en general. El presente documento muestra, a través de un modelo que combina el poder informativo de las redes y su adecuación a un modelo espacial auto regresivo (tipo panel), la importancia de incorporar al enfoque micro-prudencial (propuesto en Basilea II), una variable que capture el efecto de estar conectado con otras entidades, realizando así un análisis macro-prudencial (propuesto en Basilea III).

Essays on banking theory and history of financial arrangements

Esta tese contém dois capítulos, cada um lidando com a teoria e a história dos bancos e arranjos financeiros. No capítulo 1, busca-se extender uma economia Diamond-Dybvig com monitoramento imperfeito dos saques antecipados e realizar uma comparação do bem estar social em cada uma das alocações possíveis, como proposto em Presscott and Weinberg(2003). Esse monitoramento imperfeito é implementado a partir da comunicação indireta ( através de um meio de pagamento) entre os agentes e a máquina de depósitos e saques que é um agregado do setor produtivo e financeiro. A extensão consiste em estudar alocações onde uma fração dos agentes pode explorar o monitoramento imperfeito e fraudar a alocação contratada ao consumirem mais cedo além do limite, usando múltiplos meios de pagamento. Com a punição limitada no período de consumo tardio, essa nova alocação pode ser chamada de uma alocação separadora em contraste com as alocações agregadoras onde o agente com habilidade de fraudar é bloqueado por um meio de pagamento imune a fraude, mas custoso, ou por receber consumo futuro suficiente para tornar a fraude desinteressante. A comparação de bem estar na gama de parâmetros escolhida mostra que as alocações separadoras são ótimas para as economias com menor dotação e as agregadoras para as de nível intermediário e as ricas. O capítulo termina com um possível contexto histórico para o modelo, o qual se conecta com a narrativa histórica encontrada no capítulo 2. No capítulo 2 são exploradas as propriedade quantitativas de um sistema de previsão antecedente para crises financeiras, com as váriaveis sendo escolhidas a partir de um arcabouço de ``boom and bust'' descrito mais detalhadamente no apêndice 1. As principais variáveis são: o crescimento real nos preços de imóveis e ações, o diferencial entre os juros dos títulos governamentais de 10 anos e a taxa de 3 meses no mercado inter-bancário e o crescimento nos ativos totais do setor bancário. Essas variáveis produzem uma taxa mais elevada de sinais corretos para as crises bancárias recentes (1984-2008) do que os sistemas de indicadores antecedentes comparáveis. Levar em conta um risco de base crescente ( devido à tendência de acumulação de distorções no sistema de preços relativos em expansões anteriores) também provê informação e eleva o número de sinais corretos em países que não passaram por uma expansão creditícia e nos preços de ativos tão vigorosa.

From hard-peg to hard landing?: recent experiences of Argentina and Ecuador

Includes bibliography

Ciclos económicos, capital bancario y nuevas opciones de política económica

El objetivo de este trabajo es utilizar algunos hechos estilizados de la "Gran recesión", específicamente la drástica caída en el nivel de capitalización bancario, para analizar la relación entre los ciclos financieros y los ciclos reales, así como la efectividad de la política monetaria no convencional y las políticas macroprudenciales. Para esto, en el primer capítulo se desarrolla una microfundamentación de la banca a partir de un modelo de Costly State Verification, que es incluido posteriomente en distintas especificaciones de modelos DSGE. Los resultados muestran que: (i) los ciclos financieros y los ciclos económicos pueden relacionarse a partir del deterioro del capital bancario; (ii) Las políticas macroprudenciales y no convencionales son efectivas para moderar los ciclos económicos, pero son costosas en términos de recursos e inflación.

Chaotic dynamics in credit constrained emerging economies

This paper analyzes the role of financial development as a source of endogenous instability in small open economies. By assuming that firms face credit constraints, our model displays a complex dynamic behavior for intermediate values of the parameter representing the level of financial development of the economy. The basic implication of our model is that economies experiencing a process of financial development are more unstable than both very underdeveloped and very developed economies. Our instability concept means that small shocks have a persistent effect on the long run behavior of the model and also that economies can exhibit cycles with a very high period or even chaotic dynamic patterns.

Self-Fulfilling Price Cycles

This paper presents a model of a self-fulfilling price cycle in an asset market. Price oscillates deterministically even though the underlying environment is stationary. The mechanism that we uncover is driven by endogenous variation in the investment horizons of the different market participants, informed and uninformed. On even days, the price is high; on odd days it is low. On even days, informed traders are willing to jettison their good assets, knowing that they can buy them back the next day, when the price is low. The anticipated drop in price more than offsets any potential loss in dividend. Because of these asset sales, the informed build up their cash holdings. Understanding that the market is flooded with good assets, the uninformed traders are willing to pay a high price. But their investment horizon is longer than that of the informed traders: their intention is to hold the assets they purchase, not to resell. On odd days, the price is low because the uninformed recognise that the informed are using their cash holdings to cherry-pick good assets from the market. Now the uninformed, like the informed, are investing short-term. Rather than buy-and-hold as they do with assets purchased on even days, on odd days the uninformed are buying to sell. Notice that, at the root of the model, there lies a credit constraint. Although the informed are flush with cash on odd days, they are not deep pockets. On each cherry that they pick out of the market, they earn a high return: buying cheap, selling dear. However they don't have enough cash to strip the market of cherries and thereby bid the price up.