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Collateral amplification under complete markets

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  • Nikolov, Kalin

Abstract

This paper examines the robustness of the Kiyotaki-Moore collateral amplification mechanism to the existence of complete markets for aggregate risk. We show that, when borrowers can hedge against aggregate shocks at fair prices, the volatility of endogenous variables becomes identical to the first best in the absence of credit constraints. The collateral amplification mechanism disappears. To motivate the limited use of contingent contracts, we introduce costs of issuing contingent debt and calibrate them to match the liquidity and safety premia the data. We .find that realistic costs of state contingent market participation can rationalize the predominant use of uncontingent debt. Amplification is restored in such an environment. JEL Classification: E32, D52

Suggested Citation

  • Nikolov, Kalin, 2014. "Collateral amplification under complete markets," Working Paper Series 1716, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20141716
    Note: 288883
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    References listed on IDEAS

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    Cited by:

    1. Alfred Duncan & Charles Nolan, 2020. "Reform of the UK Financial Policy Committee," Scottish Journal of Political Economy, Scottish Economic Society, vol. 67(1), pages 1-30, February.
    2. Candian, Giacomo & Dmitriev, Mikhail, 2020. "Optimal contracts and supply-driven recessions," Economics Letters, Elsevier, vol. 197(C).
    3. Alfred Duncan & Charles Nolan, 2015. "Objectives and Challenges of Macroprudential Policy," Working Papers 2015_22, Business School - Economics, University of Glasgow.
    4. Alfred Duncan, 2016. "Private information and business cycle risk sharing," Working Papers 2016_02, Business School - Economics, University of Glasgow.
    5. Alfred Duncan & Charles Nolan, 2017. "Financial Frictions in Macroeconomic Models," Studies in Economics 1719, School of Economics, University of Kent.

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    More about this item

    Keywords

    amplification; collateral constraints;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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