Endogenous Leverage and Default in the Laboratory

65 Pages Posted: 11 Nov 2019

See all articles by Marco Cipriani

Marco Cipriani

Federal Reserve Bank of New York

Ana Fostel

University of Virginia - Department of Economics

Daniel Houser

Interdisciplinary Center for Economic Science

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2019

Abstract

We study default and endogenous leverage in the laboratory. To this purpose, we develop a general equilibrium model of collateralized borrowing amenable to laboratory implementation and gather experimental data. In the model, leverage is endogenous: agents choose how much to borrow using a risky asset as collateral, and there are no ad hoc collateral constraints. When the risky asset is financial—namely, its payoff does not depend on ownership (such as a bond)—collateral requirements are high and there is no default. In contrast, when the risky asset is nonfinancial—namely, its payoff depends on ownership (such as a firm)—collateral requirements are lower and default occurs. The experimental outcomes are in line with the theory's main predictions. The type of collateral, whether financial or not, matters. Default rates and loss from default are higher when the risky asset is nonfinancial, stemming from laxer collateral requirements. Default rates and collateral requirements move closer to the theoretical predictions as the experiment progresses.

Keywords: collateral, default, double auction, experimental economics, leverage

JEL Classification: A10, C90, G12

Suggested Citation

Cipriani, Marco and Fostel, Ana and Houser, Daniel, Endogenous Leverage and Default in the Laboratory (November 1, 2019). FRB of New York Staff Report No. 900, November 2019, Available at SSRN: https://ssrn.com/abstract=3483753 or http://dx.doi.org/10.2139/ssrn.3483753

Marco Cipriani (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
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Ana Fostel

University of Virginia - Department of Economics ( email )

237 Monroe Hall
P.O. Box 400182
Charlottesville, VA 22904-418
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Daniel Houser

Interdisciplinary Center for Economic Science ( email )

5th Floor, Vernon Smith Hall
George Mason University
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United States
7039934856 (Phone)

HOME PAGE: http://mason.gmu.edu/~dhouser/

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