Self-Fulfilling Credit Crunches

Posted: 17 Jul 2017

See all articles by Anastasios Dosis

Anastasios Dosis

ESSEC Business School; University of Cergy-Pontoise - THEMA

Date Written: July 10, 2017

Abstract

This paper develops a model of a self-fulfilling credit crunch. The model features three types of agents: investors, entrepreneurs and dealers. Investors and entrepreneurs use their labour to produce capital that is traded in a perfectly competitive market and used by entrepreneurs to produce output. Dealers purchase capital and provide loans to entrepreneurs. Entrepreneurs face a trade-off between selling their capital in the market and investing it in a risky project, which is exploited by dealers to screen out high- from low-quality projects. For a specified set of parameters, exactly two equilibria exist. In the good equilibrium, the price of capital is high, entrepreneurs are credit unconstrained and capital production is efficient, whereas in the bad equilibrium, the price of capital plunges, entrepreneurs are credit constrained and capital production is inefficient.

Keywords: capital, leverage, adverse selection, rational expectations, credit crunch

JEL Classification: D82, E30, E44, E58, G01, G21

Suggested Citation

Dosis, Anastasios, Self-Fulfilling Credit Crunches (July 10, 2017). Available at SSRN: https://ssrn.com/abstract=2999679 or http://dx.doi.org/10.2139/ssrn.2999679

Anastasios Dosis (Contact Author)

ESSEC Business School

3 Avenue Bernard Hirsch
B.P 50105
Cergy - Pontoise Cedex, NA 95021
France

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

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