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Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009

Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009. Previous literature: “Constrained borrower” view. Wealth constrained agency. Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), H ölmstrom and Tirole (1997,1998).

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Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009

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  1. Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009

  2. Previous literature: “Constrained borrower” view Wealth constrained agency Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998)

  3. Previous literature: “Constrained borrower” view Wealth constrained agency Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998) Injurious liquidation Diamond and Dybvig (1983), Schleifer and Vishny (1992), Hölmstrom and Tirole (1997),

  4. Previous literature: “Constrained borrower” view Wealth constrained agency Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998) Injurious liquidation Diamond and Dybvig (1983), Schleifer and Vishny (1992), Hölmstrom and Tirole (1997), Key idea: Shocks propagate by affecting borrower collateral

  5. This paper: “Constrained lender” view • Specialized lenders channel saving to investment – “Brealey-Myers managers”

  6. This paper: “Constrained lender” view • Specialized lenders channel saving to investment – “Brealey-Myers managers” • Lenders form long-term contractual relationships with projects, subject to agency costs

  7. This paper: “Constrained lender” view • Specialized lenders channel saving to investment – “Brealey-Myers managers” • Lenders form long-term contractual relationships with projects, subject to agency costs • Averse shocks break up projects, lenders take time to find new projects

  8. This paper: “Constrained lender” view • Specialized lenders channel saving to investment – “Brealey-Myers managers” • Lenders form long-term contractual relationships with projects, subject to agency costs • Averse shocks break up projects, lenders take time to find new projects • Household asset reallocation creates negative feedback

  9. This paper: “Constrained lender” view • Specialized lenders channel saving to investment – “Brealey-Myers managers” • Lenders form long-term contractual relationships with projects, subject to agency costs • Averse shocks break up projects, lenders take time to find new projects • Household asset reallocation creates negative feedback Den Haan, Ramey and Watson, “Liquidity Flows and Fragility of Business Enterprises,” JME, 2003

  10. Results • Agency costs  shocks propagated through lender-project relationships

  11. Results • Agency costs  shocks propagated through lender-project relationships • Household responses amplify propagation

  12. Results • Agency costs  shocks propagated through lender-project relationships • Household responses amplify propagation • Propagation is greater when shocks are more persistent

  13. Results • Agency costs  shocks propagated through lender-project relationships • Household responses amplify propagation • Propagation is greater when shocks are more persistent • Asset market feedbacks  shocks propagate across sectors

  14. Broader contribution: New approach to modeling saving and investment

  15. Broader contribution: • New approach to modeling saving and investment • Traditional model: Capital = accumulated output

  16. Broader contribution: • New approach to modeling saving and investment • Traditional model: Capital = accumulated output • Lender expertise model: Capital = accumulated managerial knowledge

  17. Model • Unit mass of households • Unit mass of specialized lenders • Periods t = 1,2,3,…

  18. Model • Unit mass of households • Unit mass of specialized lenders • Periods t = 1,2,3,… • In each period, a lender is either matched with a project or searching for a new project

  19. Model • Unit mass of households • Unit mass of specialized lenders • Periods t = 1,2,3,… • In each period, a lender is either matched with a project or searching for a new project

  20. Project surplus

  21. Project surplus

  22. Project surplus

  23. Agency cost Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000)

  24. Agency cost Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000)

  25. Project search

  26. Project search

  27. Equilibrium conditions

  28. Equilibrium conditions

  29. Equilibrium conditions

  30. Asset market

  31. Asset market Driving process

  32. Numerical example

  33. Numerical example

  34. Numerical example

  35. Extensions • Lender effort

  36. Extensions • Lender effort • Physical capital

  37. Extensions • Lender effort • Physical capital • Long-term contracting, liquidity hoarding

  38. Extensions • Lender effort • Physical capital • Long-term contracting, liquidity hoarding • Countercyclical policy – “bailouts”

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