Lender Expertise and Propagation of Credit Shocks Garey Ramey UC San Diego July 2009
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Lender Expertise and
Propagation of Credit Shocks
Garey RameyUC San Diego
July 2009
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Previous literature: “Constrained borrower” view
Stiglitz and Weiss (1981), Bernanke and Gertler (1989,1990), Kiyotaki and Moore (1997), Hölmstrom and Tirole (1997,1998)
Wealth constrained agency
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Previous literature: “Constrained borrower” view
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),
Wealth constrained agency
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Previous literature: “Constrained borrower” view
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),
Wealth constrained agency
Key idea: Shocks propagate by affecting borrower collateral
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This paper: “Constrained lender” view
1. Specialized lenders channel saving to investment – “Brealey-Myers managers”
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This paper: “Constrained lender” view
1. Specialized lenders channel saving to investment – “Brealey-Myers managers”
2. Lenders form long-term contractual relationships with projects, subject to agency costs
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This paper: “Constrained lender” view
1. Specialized lenders channel saving to investment – “Brealey-Myers managers”
2. Lenders form long-term contractual relationships with projects, subject to agency costs
3. Averse shocks break up projects, lenders take time to find new projects
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This paper: “Constrained lender” view
1. Specialized lenders channel saving to investment – “Brealey-Myers managers”
2. Lenders form long-term contractual relationships with projects, subject to agency costs
3. Averse shocks break up projects, lenders take time to find new projects
4. Household asset reallocation creates negative feedback
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This paper: “Constrained lender” view
1. Specialized lenders channel saving to investment – “Brealey-Myers managers”
2. Lenders form long-term contractual relationships with projects, subject to agency costs
3. Averse shocks break up projects, lenders take time to find new projects
4. Household asset reallocation creates negative feedback
Den Haan, Ramey and Watson, “Liquidity Flows and Fragility of Business Enterprises,” JME, 2003
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Results
1. Agency costs shocks propagated through lender-project relationships
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Results
1. Agency costs shocks propagated through lender-project relationships
2. Household responses amplify propagation
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Results
1. Agency costs shocks propagated through lender-project relationships
2. Household responses amplify propagation
3. Propagation is greater when shocks are more persistent
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Results
1. Agency costs shocks propagated through lender-project relationships
2. Household responses amplify propagation
3. Propagation is greater when shocks are more persistent
4. Asset market feedbacks shocks propagate across sectors
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Broader contribution:
New approach to modeling saving and investment
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Broader contribution:
New approach to modeling saving and investment
Traditional model: Capital = accumulated output
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Broader contribution:
New approach to modeling saving and investment
Traditional model: Capital = accumulated output
Lender expertise model: Capital = accumulated managerial knowledge
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Model
• Unit mass of households
• Unit mass of specialized lenders
• Periods t = 1,2,3,…
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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
tnt periodin produce that projects ofnumber
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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
tnt periodin produce that projects ofnumber
ianz ittt project ofoutput 1
itit aaG offunction on distributi )(
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lueproject va )( itt aV
lender unmatched of valuetU
Project surplus
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lueproject va )( itt aV
lender unmatched of valuetU
Project surplus
tittitt U(aVaS ) surplusproject )(
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lueproject va )( itt aV
lender unmatched of valuetU
yprobabilit eobsolesenc exogenous
Project surplus
tittitt U(aVaS ) surplusproject )(
}0,])'()'()1[(max{0
1111
ttttittt UadGaSEanz
factordiscount stochastic 1 t
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costagency x
surplusproject from extractedrent
Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000)
Agency cost
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costagency x
surplusproject from extractedrent
Surplus must cover this cost or project is terminated – Ramey and Watson (1997,1999,2000)
Agency cost
marginrmination project te tR
xRS tt )(
costagency cover tosurplus sufficient tit Ra
d terminateisproject surplus,nt insufficie tit Ra
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Project search
lenders searching ofnumber 1 tt nv
yprobabilit findingproject }1,min{ tt Avp
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Project search
lenders searching ofnumber 1 tt nv
yprobabilit findingproject }1,min{ tt Avp
0
111 ])'()'([ tttttt UadGaSpEU
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Equilibrium conditions
1
)'()'( 1
tRt xadGRa
1111
1 )1(
tttttttt nzEpRnz
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Equilibrium conditions
1
)'()'( 1
tRt xadGRa
1111
1 )1(
tttttttt nzEpRnz
))1))(((1( 11 ttttt vpnRGn
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Equilibrium conditions
1
)'()'( 1
tRt xadGRa
tR
ttt adGanzy output aggregate )'('
1111
1 )1(
tttttttt nzEpRnz
))1))(((1( 11 ttttt vpnRGn
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Asset market
functionutility household 10
1
0
t
tt cE
tt yc cost agency consumes Household
11
t
tt y
y
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Asset market
functionutility household 10
1
0
t
tt cE
Driving process
11
tezz tt
tt yc cost agency consumes Household
11
t
tt y
y
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Numerical example
2. ,0 lognormal, )( itaG
22. that sochosen AvA
8.,1,99.,02.,8.
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Numerical example
2. ,0 lognormal, )( itaG
22. that sochosen AvA
8.,1,99.,02.,8.
07.)(,56.1,78.,72. RGynR
:statesteady 1x
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Numerical example
2. ,0 lognormal, )( itaG
22. that sochosen AvA
8.,1,99.,02.,8.
02.)(,90.1,92.,0 RGynR
07.)(,56.1,78.,72. RGynR
:statesteady 1x
:statesteady 0x
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Extensions
1. Lender effort
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Extensions
1. Lender effort
2. Physical capital
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Extensions
1. Lender effort
2. Physical capital
3. Long-term contracting, liquidity hoarding
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Extensions
1. Lender effort
2. Physical capital
3. Long-term contracting, liquidity hoarding
4. Countercyclical policy – “bailouts”