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Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis
Author:
Mr. Enrique G. Mendoza null

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and
Ms. Emine Boz
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Series:
IMF Working Papers
Volume/Issue:
Volume 2010: Issue 164
Language:
English
Publication Date:
01 Jul 2010
DOI:
https://doi.org/10.5089/9781455201754.001
ISBN:
9781455201754
ISSN:
1018-5941
Pages:
62
Keywords:
WP; financial crisis; credit market
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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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.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund