Haircut Cycles

42 Pages Posted: 21 Jun 2019

See all articles by Tong Zhang

Tong Zhang

BI Norwegian Business School

Date Written: April 16, 2019


This paper contributes to the literature on the effect of financial frictions on business cycle activity. We follow the "leverage cycles" approach in the spirit of Geanakoplos (2010) which argues that equilibrium fluctuations in collateral rates (equivalently haircuts, margins, or leverage), rather than just in interest rates, are a key driver of persistent fluctuations in economic activity. In particular, we focus on how adverse economic shocks can be amplified and prolonged by endogenous variations in haircuts in the standard macrofinance framework à la Kiyotaki and Moore (1997). In our model, collateral constraints are motivated by no-recourse loans, and the interest rate and the haircut are jointly determined as general equilibrium objects. We highlight the difference between the risk and the illiquidity of the collateral in determining the credit market equilibrium: an increase in risk increases both the interest rate and the haircut, while an increase in illiquidity increases the haircut but decreases the interest rate. Compared with the previous literature, our model allows us to decompose the transmission of adverse shocks through the credit market into the interest rate channel and the haircut channel, and evaluate their relative importance. The numerical exercises illustrate that risk shocks can generate sizable business cycle fluctuations through the credit market, and the haircut channel is dominant in times of low market liquidity.

JEL Classification: D53, E13, E32, E44, G01

Suggested Citation

Zhang, Tong, Haircut Cycles (April 16, 2019). Available at SSRN: or

Tong Zhang (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0484

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