Subprime Mortgages and Banking in a DSGE Model

40 Pages Posted: 23 Jun 2017

See all articles by Martino Ricci

Martino Ricci

European Central Bank (ECB)

Patrizio Tirelli

Department of Economics and Management; Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

Date Written: June 22, 2017

Abstract

Can a DSGE model replicate the financial crisis effects without assuming unprecedented and implausibly large shocks? Starting from the assumption that the subprime crisis triggered the financial crisis, we introduce balance-sheet effects for housing market borrowers and for commercial banks in an otherwise standard DSGE model. Our crisis experiment is initiated by a shock to subprime lending risk, which is calibrated to match the observed increase in subprime delinquency rates. Due to contagion of prime borrowers and to the ensuing adverse effect on banks balance sheets, this apparently small shock is sufficient to trigger a decline in housing investment comparable to what was observed during the financial crisis. The adverse effect of sub-primers risk on commercial banks’ agency problem is a crucial driver of our results.

Keywords: Housing, Mortgage Default, Subprime Risk, DSGE

JEL Classification: E32, E44, G01, R31

Suggested Citation

Ricci, Martino and Tirelli, Patrizio, Subprime Mortgages and Banking in a DSGE Model (June 22, 2017). University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 366, Available at SSRN: https://ssrn.com/abstract=2991333 or http://dx.doi.org/10.2139/ssrn.2991333

Martino Ricci

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Patrizio Tirelli (Contact Author)

Department of Economics and Management ( email )

Corso Strada Nuova, 65
27100 Pavia, 27100
Italy

HOME PAGE: http://https://sites.google.com/site/patriziotirellihomepage/

Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

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