Balance Sheet Recessions with Informational and Trading Frictions

53 Pages Posted: 17 Feb 2015 Last revised: 13 Aug 2015

See all articles by Vladimir Asriyan

Vladimir Asriyan

CREI; Barcelona GSE; Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Date Written: July 22, 2015

Abstract

Balance sheet recessions result from concentration of macroeconomic risks on the balance sheets of leveraged agents. In this paper, I argue that information dispersion about the future states of the economy combined with trading frictions in financial markets can explain why such concentration of risk may be privately but not socially optimal. I show that borrowers face a tradeoff between the insurance benefits of financing with macro contingent contracts and the illiquidity premia they need to pay creditors for holding such contracts. In aggregate, as borrowers sacrifice contingency in order to provide liquidity, the severity of macroeconomic fluctuations becomes endogenously linked to the magnitudes of information dispersion and trading frictions. In this setting, I study the policy implications of the theory and I find that imposing (or subsidizing) contingencies in private contracts is welfare improving.

Keywords: Balance sheet recessions, contingent contracts, liquidity, informational frictions, trading frictions, financial regulation

JEL Classification: E32, E44, G1

Suggested Citation

Asriyan, Vladimir, Balance Sheet Recessions with Informational and Trading Frictions (July 22, 2015). Available at SSRN: https://ssrn.com/abstract=2565603 or http://dx.doi.org/10.2139/ssrn.2565603

Vladimir Asriyan (Contact Author)

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

HOME PAGE: http://crei.cat/people/asriyan/welcome.html

Barcelona GSE ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

HOME PAGE: http://www.barcelonagse.eu/Faculty.php?id=510

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

HOME PAGE: http://www.econ.upf.edu/en/people/onefaculty.php?id=p7040

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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