Endogenous Credit, Business Cycle, and Portfolio Selection

28 Pages Posted: 6 Feb 2015 Last revised: 1 Nov 2023

See all articles by Kyoung Jin Choi

Kyoung Jin Choi

University of Calgary - Haskayne School of Business

Hyeng Keun Koo

Ajou University - Department of Business Administration

Byung Hwa Lim

Department of Fintech, SKK Business School, Sungkyunkwan University

Jane Yoo

Ajou University - School of Business

Date Written: October 25, 2023

Abstract

We study a continuous-time model of consumption and portfolio selection of an agent with a limited ability to commit to a debt contract in which the credit limit is endogenously determined. We consider the case where the agent borrows against future income and/or collateral assets. We also study the determination of the credit limit in a general equilibrium model. We derive the credit limit in closed form. The credit limit is smaller than the natural limit due to limited commitment and an increasing function of both income and the collateral price. We extend the baseline model to the case with a regime switch and show that the credit limit is cyclical: it is lower (higher) when the Sharpe ratio is high (low). The model predicts that the rich tend to increase the proportion of risky investments in downturns, whereas the poor decrease them.

Keywords: Endogenous Credit, Limited Commitment, Business Cycle, Consumption and Portfolio selection, General Equilibrium

JEL Classification: C61, C73, D11, D15, G11

Suggested Citation

Choi, Kyoung Jin and Koo, Hyeng Keun and Lim, Byung Hwa and Yoo, Jane, Endogenous Credit, Business Cycle, and Portfolio Selection (October 25, 2023). Available at SSRN: https://ssrn.com/abstract=2560607 or http://dx.doi.org/10.2139/ssrn.2560607

Kyoung Jin Choi

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

HOME PAGE: http://sites.google.com/site/kyoungjinchoiecon/

Hyeng Keun Koo

Ajou University - Department of Business Administration ( email )

206 Worldcup-ro
Yeongtong-gu
Suwon, 443-749
Korea, Republic of (South Korea)

Byung Hwa Lim

Department of Fintech, SKK Business School, Sungkyunkwan University ( email )

25-2, SUNGKYUNKWAN-RO, JONGNO-GU
Seoul, Seoul 03063
027600450 (Phone)

Jane Yoo (Contact Author)

Ajou University - School of Business ( email )

206 Worldcup-ro
Yeongtong-gu
Suwon
Korea, Republic of (South Korea)

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