Correlated Leverage and Its Ramifications

49 Pages Posted: 18 Mar 2009 Last revised: 18 Mar 2014

See all articles by Anand M. Goel

Anand M. Goel

Stevens Institute of Technology

Fenghua Song

Pennsylvania State University - Smeal College of Business

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: March 17, 2014


This paper develops a theory in which housing prices, the capital structures of banks that make mortgage loans and the capital structures of borrowers who take these loans are all endogenously determined in equilibrium. There are four main results. First, leverage is a "positively correlated" phenomenon in that high leverage among borrowers is positively correlated with high leverage among banks. Both borrower and bank leverage are higher when house prices are higher. First-time homebuyers with fixed wealth endowments must borrow more to buy more expensive homes, whereas higher current house prices rationally imply higher expected future house prices and therefore higher collateral values, inducing banks to be more highly levered. Second, higher bank leverage leads to greater volatility of house prices in response to shocks to fundamental house values. Third, a bank's exposure to credit risk depends not only on its own leverage but also on the leverage decisions of other banks. Fourth, positive fundamental shocks to house prices dilute financial intermediation by reducing banks' pre-lending screening, and this reduction in bank screening further increases house prices. Empirical and policy implications of the analysis are drawn out, and empirical evidence is provided for the first two predictions. The key policy implications are that greater geographic diversification by banks, tying mortgage tax exemptions to the duration of home ownership, and increasing bank capital requirements when borrower leverage is high can help reduce house price volatility.

Keywords: Housing Market, Collateral, Bank Leverage, Borrower Leverage

JEL Classification: G21

Suggested Citation

Goel, Anand Mohan and Song, Fenghua and Thakor, Anjan V., Correlated Leverage and Its Ramifications (March 17, 2014). Available at SSRN: or

Anand Mohan Goel

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States


Fenghua Song (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814.863.4905 (Phone)


Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

European Corporate Governance Institute (ECGI) ( email )

B-1050 Brussels

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