IDEAS home Printed from https://ideas.repec.org/a/spr/joecth/v70y2020i2d10.1007_s00199-019-01222-7.html
   My bibliography  Save this article

Debt collateralization, capital structure, and maximal leverage

Author

Listed:
  • Feixue Gong

    (Massachusetts Institute of Technology)

  • Gregory Phelan

    (Williams College)

Abstract

We study the effects of allowing risky debt to be used as collateral in a general equilibrium model with heterogeneous agents and collateralized financial contracts. With debt collateralization, investors switch to using exclusively high-leverage contracts for every investment they choose (issuing risky debt when possible). High-leverage positions maximize the ability of contracts to serve as collateral, expanding the set of state contingencies created from collateralized debt. We provide conditions under which debt collateralization will increase the price of the underlying asset. Our results also apply to variations in capital structure since many capital structures implicitly provide the ability to use debt contracts as collateral.

Suggested Citation

  • Feixue Gong & Gregory Phelan, 2020. "Debt collateralization, capital structure, and maximal leverage," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(2), pages 579-605, September.
  • Handle: RePEc:spr:joecth:v:70:y:2020:i:2:d:10.1007_s00199-019-01222-7
    DOI: 10.1007/s00199-019-01222-7
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s00199-019-01222-7
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.

    File URL: https://libkey.io/10.1007/s00199-019-01222-7?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Nicola Gennaioli & Andrei Shleifer & Robert W. Vishny, 2013. "A Model of Shadow Banking," Journal of Finance, American Finance Association, vol. 68(4), pages 1331-1363, August.
    2. Piero Gottardi & Felix Kubler, 2015. "Dynamic Competitive Economies with Complete Markets and Collateral Constraints," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(3), pages 1119-1153.
    3. Ana Fostel & John Geanakoplos, 2012. "Leverage and Default in Binomial Economies: A Complete Characterization," Cowles Foundation Discussion Papers 1877RRR, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
    4. John Geanakoplos & William Zame, 2014. "Collateral equilibrium, I: a basic framework," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 56(3), pages 443-492, August.
    5. Kurt Mitman & Gianluca Violante & Greg Kaplan, 2015. "Consumption and House Prices in the Great Recession: Model Meets Evidence," 2015 Meeting Papers 275, Society for Economic Dynamics.
    6. Rampini, Adriano A. & Viswanathan, S., 2013. "Collateral and capital structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 466-492.
    7. Piero Gottardi & Vincent Maurin & Cyril Monnet, 2019. "A theory of repurchase agreements, collateral re-use, and repo intermediation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 30-56, July.
    8. Dan Vu Cao, 2010. "Collateral Shortages, Asset Price And Investment Volatility With Heterogeneous Beliefs," 2010 Meeting Papers 1233, Society for Economic Dynamics.
    9. Anil Shivdasani & Yihui Wang, 2011. "Did Structured Credit Fuel the LBO Boom?," Journal of Finance, American Finance Association, vol. 66(4), pages 1291-1328, August.
    10. Araújo, Aloísio & Kubler, Felix & Schommer, Susan, 2012. "Regulating collateral-requirements when markets are incomplete," Journal of Economic Theory, Elsevier, vol. 147(2), pages 450-476.
    11. Piero Gottardi & Vincent Maurin & Cyril Monnet, 2019. "A theory of repurchase agreements, collateral re-use, and repo intermediation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 30-56, July.
    12. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
    13. Dan Cao & Guangyu Nie, 2017. "Amplification and Asymmetric Effects without Collateral Constraints," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(3), pages 222-266, July.
    14. Zame, William R, 1993. "Efficiency and the Role of Default When Security Markets Are Incomplete," American Economic Review, American Economic Association, vol. 83(5), pages 1142-1164, December.
    15. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
    16. Marco Pagano & Paolo Volpin, 2012. "Securitization, Transparency, and Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 25(8), pages 2417-2453.
    17. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-1244, September.
    18. Ana Fostel & John Geanakoplos, 2012. "Leverage and Default in Binomial Economies: A Complete Characterization," Cowles Foundation Discussion Papers 1877R3, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
    19. Ana Fostel & John Geanakoplos, 2016. "Financial Innovation, Collateral, and Investment," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 242-284, January.
    20. Madan, Dilip & Soubra, Badih, 1991. "Design and Marketing of Financial Products," The Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 361-384.
    21. Ji Shen & Hongjun Yan & Jinfan Zhang, 2014. "Collateral-Motivated Financial Innovation," The Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 2961-2997.
    22. Michael Lemmon & Laura Xiaolei Liu & Mike Qinghao Mao & Greg Nini, 2014. "Securitization and Capital Structure in Nonfinancial Firms: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 69(4), pages 1787-1825, August.
    23. Ana Fostel & John Geanakoplos, 2015. "Leverage and Default in Binomial Economies: A Complete Characterization," Econometrica, Econometric Society, vol. 83, pages 2191-2229, November.
    24. John Geanakoplos, 2010. "The Leverage Cycle," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 1-65, National Bureau of Economic Research, Inc.
    25. Alp Simsek, 2013. "Belief Disagreements and Collateral Constraints," Econometrica, Econometric Society, vol. 81(1), pages 1-53, January.
    26. Phelan, Gregory & Toda, Alexis Akira, 2019. "Securitized markets, international capital flows, and global welfare," Journal of Financial Economics, Elsevier, vol. 131(3), pages 571-592.
    27. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
    28. Johannes Brumm & Michael Grill & Felix Kubler & Karl Schmedders, 2015. "Collateral Requirements And Asset Prices," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56, pages 1-25, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Nikolaos Romanidis & Dimitrios P. Tsomocos, 2022. "Default and determinacy under quantitative easing," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(1), pages 95-111, July.
    2. Zehao Liu & Chengbo Xie, 2023. "Haircuts, interest rates, and credit cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(1), pages 69-109, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Feixue Gong & Gregory Phelan, 2023. "Collateral constraints, tranching, and price bases," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(2), pages 317-340, February.
    2. Phelan, Gregory & Toda, Alexis Akira, 2019. "Securitized markets, international capital flows, and global welfare," Journal of Financial Economics, Elsevier, vol. 131(3), pages 571-592.
    3. Karlis, Alexandros & Galanis, Girogos & Terovitis, Spyridon & Turner, Matthew, 2017. "Heterogeneity and Clustering of Defaults," Economic Research Papers 270011, University of Warwick - Department of Economics.
    4. A. K. Karlis & G. Galanis & S. Terovitis & M. S. Turner, 2021. "Heterogeneity and clustering of defaults," Quantitative Finance, Taylor & Francis Journals, vol. 21(9), pages 1533-1549, September.
    5. Zehao Liu & Chengbo Xie, 2023. "Haircuts, interest rates, and credit cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(1), pages 69-109, July.
    6. Bengui, Julien & Phan, Toan, 2018. "Asset pledgeability and endogenously leveraged bubbles," Journal of Economic Theory, Elsevier, vol. 177(C), pages 280-314.
    7. Viktoria Baklanova & Cecilia Caglio & Marco Cipriani & Adam Copeland, 2019. "The Use of Collateral in Bilateral Repurchase and Securities Lending Agreements," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 228-249, July.
    8. Denis Gromb & Dimitri Vayanos, 2018. "The Dynamics of Financially Constrained Arbitrage," Journal of Finance, American Finance Association, vol. 73(4), pages 1713-1750, August.
    9. Laura Bakkensen & Toan Phan & Russell Wong, 2023. "Leveraging the Disagreement on Climate Change: Theory and Evidence," Working Paper 23-01, Federal Reserve Bank of Richmond.
    10. Maurin, Vincent, 2022. "Asset scarcity and collateral rehypothecation," Journal of Financial Intermediation, Elsevier, vol. 52(C).
    11. ÅžimÅŸek, Alp, 2021. "The Macroeconomics of Financial Speculation," CEPR Discussion Papers 15733, C.E.P.R. Discussion Papers.
    12. Gregory Phelan, 2017. "Collateralized borrowing and increasing risk," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(2), pages 471-502, February.
    13. Wang, F. Albert, 2022. "Double leverage cycle, interest rate, and financial crisis," Journal of Financial Stability, Elsevier, vol. 58(C).
    14. John Geanakoplos, 2022. "Leverage Cycle Theory of Economic Crises and Booms," Cowles Foundation Discussion Papers 2370, Cowles Foundation for Research in Economics, Yale University.
    15. Fostel, Ana & Geanakoplos, John, 2012. "Why does bad news increase volatility and decrease leverage?," Journal of Economic Theory, Elsevier, vol. 147(2), pages 501-525.
    16. Suzuki, Shiba, 2018. "Inequality and asset fire sales," MPRA Paper 90906, University Library of Munich, Germany.
    17. Magill, Michael & Quinzii, Martine, 2015. "Prices and investment with collateral and default," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 111-132.
    18. Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
    19. Sangyup Choi & Inkee Jang & Kee-Youn Kang & Hyunpyung Kim, 2024. "Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory," Working Papers 11, University of Liverpool, Department of Economics.
    20. Bloise, G. & Citanna, A., 2019. "Asset shortages, liquidity and speculative bubbles," Journal of Economic Theory, Elsevier, vol. 183(C), pages 952-990.

    More about this item

    Keywords

    Leverage; Incomplete markets; Asset prices; Default; Securitized markets; Asset-backed securities; Collateralized debt obligations;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:joecth:v:70:y:2020:i:2:d:10.1007_s00199-019-01222-7. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.