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Aggregate Implications of Belief Heterogeneity

Paper Session

Saturday, Jan. 6, 2018 10:15 AM - 12:15 PM

Pennsylvania Convention Center, 102-A
Hosted By: American Economic Association
  • Chair: Jose Scheinkman, Columbia University

Global Collateral: How Financial Innovation Drives Capital Flows and Increases Financial Instability

Ana Fostel
,
University of Virginia
John Geanakoplos
,
Yale University
Gregory Phelan
,
Williams College

Abstract

Cross-border financial flows arise when countries differ in their abilities to use assets as collateral to back financial contracts. Foreign demand for collateral and for collateral-backed financial promises increases the collateral value of domestic assets, and cheap foreign assets provide attractive returns to Home investors who do not demand collateral to issue promises. Global flows export and amplify financial volatility: both Home and Foreign asset prices become more volatile following financial integration. Gross flows driven by collateral differences can collapse following bad news about fundamentals. Our results explain financial flows among rich, similarly-developed countries, and why these flows increase volatility.

Learning About the Neighborhood

Zhenyu Gao
,
Chinese University of Hong Kong
Michael Sockin
,
University of Texas-Austin
Wei Xiong
,
Princeton University

Abstract

We develop a model of neighborhood choice to analyze information aggregation and learning in residential and commercial real estate markets. In the presence of pervasive informational frictions, housing prices serve as important signals to households and commercial real estate developers about the economic strength of a neighborhood. Through this learning channel, noise from supply and demand shocks can propagate from housing prices to real activity, distorting not only migration into the neighborhood, but also the supply of commercial real estate as it is an input to production. Our analysis helps to rationalize the commercial real estate boom that accompanied the recent U.S. housing boom, even though commercial real estate was not subject to the household credit expansion that had contributed to the housing boom.

A Risk-centric Model of Demand Recessions and Macroprudential Policy

Ricardo Caballero
,
Massachusetts Institute of Technology
Alp Simsek
,
Massachusetts Institute of Technology

Abstract

When investors are unwilling to hold the economy's risk, a decline in the interest rate increases the Sharpe ratio of the market and equilibrates the risk markets. If the interest rate is constrained from below, risk markets are instead equilibrated via a decline in asset prices. However, the latter drags down aggregate demand, which further drags prices down, and so on. If investors are pessimistic about the recovery, the economy becomes highly susceptible to downward spirals due to dynamic feedbacks between asset prices, aggregate demand, and growth. In this context, belief disagreements generate highly destabilizing speculation that motivates macroprudential policy.

House Price Beliefs and Leverage Choice

Michael C. Bailey
,
Facebook
Eduardo Davila
,
New York University
Theresa Kuchler
,
New York University
Johannes Stroebel
,
New York University

Abstract

We study the effects of homebuyers' beliefs about future house prices on mortgage leverage choice. We first show that, from a theoretical perspective, the relationship between homebuyers' beliefs and leverage choice is ambiguous, and depends on homebuyers' willingness to adjust their house size in response to beliefs about future house price changes. When households primarily maximize the levered return of their property investment, more optimistic homebuyers take on more leverage to purchase larger houses and profit from the greater perceived price appreciation (housing-as-investment scenario). On the other hand, when considerations such as family size pin down the desired property size, more optimistic homebuyers take on less leverage to finance that property of fixed size, since they perceive a higher marginal cost of borrowing (housing-as-consumption scenario). To determine which scenario better describes the data, we empirically investigate the cross-sectional relationship between beliefs and leverage in the U.S. housing market. Our data combine mortgage financing information and a housing expectation survey with anonymized social network data from Facebook. The survey documents that an individual's belief distribution about future house price changes is affected by the recent house price experiences of her geographically-distant friends, allowing us to exploit these experiences as quasi-orthogonal shifters of individuals' beliefs. We show that more optimistic homebuyers use less leverage, consistent with the housing-as-consumption scenario; as predicted by the model, the cross-sectional relationship between beliefs and leverage choice is largest during periods when agents expect prices to fall on average.
Discussant(s)
Maryam Farboodi
,
Princeton University
Itay Goldstein
,
University of Pennsylvania
Jaroslav Borovicka
,
New York University
Jose Scheinkman
,
Columbia University
JEL Classifications
  • E3 - Prices, Business Fluctuations, and Cycles