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ENDOGENOUS CREDIT AND INVESTMENT CYCLES WITH ASSET PRICE VOLATILITY

  • Francesco Carli (a1) and Leonor Modesto (a2)
Abstract

It is commonly accepted that credit market frictions are an important source of macroeconomic fluctuations. But what is the link between the two? And what is the driving factor of asset prices volatility? To answer these questions, we have introduced a specific credit friction, limited commitment, in a general equilibrium model with production and investment in productive capital, where agents can trade bonds. The model always displays a stationary equilibrium where bonds are traded. More importantly, limited commitment may generate stochastic endogenous fluctuations driven by self-fulfilling volatile expectations (sunspots), yielding credit and investment cycles and bond price volatility consistent with data.

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Address correspondence to: Francesco Carli, Deakin Business School, 270 Elgar Road, Burwood, VIC 3125, Australia; e-mail: fcarli@deakin.edu.au.
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We are grateful to two anonymous referees for extensive feedback and to Rui Albuquerque, Teresa Lloyd-Braga, Xavier Raurich, Catarina Reis, Pedro Teles, and Alain Venditti for helpful discussions, as well as seminar participants at Católica-Lisbon, the V IIBEO Workshop, the 2014 PET Conference, the 3rd LuBraMacro Meeting, the 2014 ASSET Annual Meeting, the 2015 Conference on Financial and Real Interdependencies, and the Second International Workshop on Financial Markets and Nonlinear Dynamics. Leonor Modesto acknowledges the support from FCT—Portuguese Foundation of Science and Technology for the project PTDC/IIM-ECO/4831/2014.

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This list contains references from the content that can be linked to their source. For a full set of references and notes please see the PDF or HTML where available.

Costas Azariadis and Leo Kaas (2007) Asset price fluctuations without aggregate shocks. Journal of Economic Theory 136 (1), 126143.

John Duffy and Chris Papageorgiou (2000) A cross-country empirical investigation of the aggregate production function specification. Journal of Economic Growth 5 (1), 87120.

Urban Jermann and Vincenzo Quadrini (2012) Macroeconomic effects of financial shocks. American Economic Review 102 (1), 238271.

Césaire A. Meh and Kevin Moran (2010) The role of bank capital in the propagation of shocks. Journal of Economic Dynamics and Control 34 (3), 555576.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
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