Securitization and Leverage in General Equilibrium
44 Pages Posted: 7 Oct 2013 Last revised: 1 Jul 2015
Date Written: June 30, 2015
I develop a highly tractable dynamic general equilibrium model with collateralized lending and securitization in which asset-backed securities (ABS) function as a mechanism for risk sharing. Entrepreneurs who face aggregate and idiosyncratic investment risks can borrow from a menu of non-recourse loans offered by financial intermediaries by putting up their investments as collateral. The intermediaries pool debt contracts, issue ABS, and sell them to entrepreneurs. In addition to establishing equilibrium existence, I prove that in equilibrium only the lowest collateral loan market will be active and the entrepreneurs will leverage to maximum, leading to the endogenous emergence of "subprime" loans. Despite moral hazard by entrepreneurs, moderate collateral requirement improves welfare and economic growth.
Keywords: collateral, default, efficiency, growth, moral hazard, risk sharing
JEL Classification: D52, D53, D58, D9, G11, G21, G23
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