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CREDIT FRICTIONS, COLLATERAL, AND THE CYCLICAL BEHAVIOR OF THE FINANCE PREMIUM

Published online by Cambridge University Press:  15 February 2013

Pierre-Richard Agénor ,
George J. Bratsiotis  and
Damjan Pfajfar
Pierre-Richard Agénor
Affiliation:
University of Manchester and Centre for Growth and Business Cycle Research
George J. Bratsiotis*
Affiliation:
University of Manchester and Centre for Growth and Business Cycle Research
Damjan Pfajfar
Affiliation:
CentER EBC and University of Tilburg
*
Address correspondence to: George J. Bratsiotis, School of Social Sciences, University of Manchester, Oxford Road, M13 9PL, Manchester, UK; e-mail: george.j.bratsiotis@manchester.ac.uk.
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Abstract

This paper examines the behavior of the finance premium after technology and monetary shocks in a dynamic stochastic general equilibrium (DSGE) model where borrowers use a fraction of their production (output) as collateral. We show that this simple framework is capable of producing a countercyclical finance premium, while matching the well-documented stylized facts of macro dynamics. A key feature is the endogenous derivation of the default probability from break-even conditions, which results in the loan rate being set as a countercyclical finance premium over the cost of borrowing from the central bank. The latter is shown to provide an accelerator effect through which shocks can amplify the loan spread and the dynamic response of macro variables.

Keywords

Credit FrictionsBusiness CyclesCollateralFinance Premium
Type
Articles
Information
Macroeconomic Dynamics , Volume 18 , Issue 5 , July 2014 , pp. 985 - 997
Copyright
Copyright © Cambridge University Press 2013 

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