Abstract
We investigate the recent financial crisis with an emphasis on the interlock among housing, mortgage, and credit markets. Following Geanakoplos (Econometric Society Monographs 2:170–205, 2003, 2010), we develop a model in which both prices of the mortgage and its collateral are simultaneously and endogenously determined. Our empirical tests confirm the model’s prediction that an adverse change in the risk free rate or the loan recovery rate can trigger the financial crisis as we observed. Finally, we discuss how the pro-cyclical leveraging practice by financial intermediaries can magnify their losses in mortgage-related assets and consequently cause significant contraction in the balance sheets of these firms.
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Notes
He and Xiong (2010) also extend Geanakoplos (2003, 2010) with a similar emphasis on the role of collateral on asset pricing. While He and Xiong (2010) focus on the optimal maturity choice of the mortgage debt in a multi-period setting, we focus on the fact that the mortgage debt is essentially a derivative (hence redundant) asset given the underlying house and the risk free bond in a one-shot model.
The data can be downloaded at http://research.stlouisfed.org/fred2/series/UMCSENT/ and more information about the data is available at http://www.sca.isr.umich.edu/ .
The test results do not change qualitatively without such transformation.
We thank Moody’s for providing this data.
The index is downloaded from http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices.
Note that the expected house price is an ex ante measure in our model.
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Acknowledgments
The authors thank an anomalous referee for providing helpful comments. The authors are grateful to Edward Altman for providing the Altman-NYU Salomon Center Corporate Bond Default Master Database used in this study.
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Wang, F.A., Zhang, T. Financial Crisis and Credit Crunch in the Housing Market. J Real Estate Finan Econ 49, 256–276 (2014). https://doi.org/10.1007/s11146-013-9421-4
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DOI: https://doi.org/10.1007/s11146-013-9421-4