The Collateralizability Premium

A common prediction of macroeconomic models of credit market frictions is that the tightness of financial constraints is countercyclical. Theory suggests a negative collateralizability premium; that is, capital that can be used as collateral to relax financial constraints insures against aggregate shocks and commands a lower risk compensation compared with noncollateralizable assets. We show that a long-short portfolio constructed using a novel measure of asset collateralizability generates an average excess return of around 8% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the collateralizability premium.

Credit Market Frictions, Business Cycles, and Monetary Policy: The Research Contributions of Charles Carlstrom and Timothy Fuerst

Charles Carlstrom and Timothy Fuerst were prolific and prominent research economists who, until their untimely deaths a few years ago, were long-associated with the Federal Reserve Bank of Cleveland. Their myriad contributions include the incorporation of financial market imperfections into macroeconomic models and the study of optimal monetary policy. We provide an overview of their work and summarize a few key themes from a research conference held in their honor.

Liquidity Constraints

The theory of intertemporal choice that we have developed so far assumes that there are no imperfections in the credit market. The ability to borrow and save as much as needed—imposing only the intertemporal budget constraint—allows the transfer of resources over time and thus maintenance of a stable consumption profile through the life cycle. The chapter studies how the consumer’s problem changes in the presence of credit market frictions. The latter may explain why consumption growth is sensitive to expected changes in income (excess sensitivity of consumption) and why it is greater than predicted by the certainty equivalence model (excess growth of consumption).

ENDOGENOUS CREDIT AND INVESTMENT CYCLES WITH ASSET PRICE VOLATILITY

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.