Endogenous Leverage and Default in the Laboratory

38 Pages Posted: 18 Nov 2019

See all articles by Marco Cipriani

Marco Cipriani

Federal Reserve Bank of New York

Ana Fostel

University of Virginia - Department of Economics

Daniel Houser

George Mason University - Department of Economics; Interdisciplinary Center for Economic Science; George Mason University - Mercatus Center

Multiple version iconThere are 2 versions of this paper

Date Written: November 2019

Abstract

We study default and endogenous leverage in the laboratory. To this purpose, we develop a general equilibrium model of collateralized borrowing amenable to laboratory implementation and gather experimental data. In the model, leverage is endogenous: agents choose how much to borrow using a risky asset as collateral, and there are no ad-hoc collateral constraints. When the risky asset is financial, namely, its payoff does not depend on ownership (such as a bonds), collateral requirements are high and there is no default. In contrast, when the risky asset is non-financial, namely, its payoff depends on ownership (such as a firm), collateral requirements are lower and default occurs. The experimental outcomes are in line with the theory's main predictions. The type of collateral, whether financial or not, matters. Default rates and loss from default are higher when the risky asset is non-financial, stemming from laxer collateral requirements. Default rates and collateral requirements are closer to the theoretical predictions as the experiment progresses.

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Suggested Citation

Cipriani, Marco and Fostel, Ana and Houser, Daniel, Endogenous Leverage and Default in the Laboratory (November 2019). NBER Working Paper No. w26469, Available at SSRN: https://ssrn.com/abstract=3488969

Marco Cipriani (Contact Author)

Federal Reserve Bank of New York ( email )

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Ana Fostel

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Daniel Houser

George Mason University - Department of Economics ( email )

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George Mason University - Mercatus Center ( email )

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