Habits and Leverage
55 Pages Posted: 30 Nov 2016 Last revised: 10 Jun 2017
Date Written: June 7, 2017
Many stylized facts of leverage, trading, and asset prices obtain in a frictionless general equilibrium model that features agents' heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in expansions when asset prices are high, volatility is low, and levered agents enjoy a "consumption boom." Our model is consistent with poorer agents borrowing more and with intermediaries' leverage being a priced factor. In crises, levered agents strongly deleverage by "fire selling" their risky assets as asset prices drop. Yet, consistently with the data, their debt-to-wealth ratios increase as higher discount rates make their wealth decline faster.
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