Fire Sales and the Financial Accelerator

During periods of financial turmoil, increases in risk lead to higher default, foreclosure, and fire sales. This paper introduces a costly liquidation process for foreclosed collateral and endogenous recovery rates in a dynamic stochastic general equilibrium model of the financial accelerator. Consi...

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Bibliographic Details
Main Author: Choi, Woon
Other Authors: Cook, David
Format: eBook
Language:English
Published: Washington, D.C. International Monetary Fund 2010
Series:IMF Working Papers
Online Access:
Collection: International Monetary Fund - Collection details see MPG.ReNa
Description
Summary:During periods of financial turmoil, increases in risk lead to higher default, foreclosure, and fire sales. This paper introduces a costly liquidation process for foreclosed collateral and endogenous recovery rates in a dynamic stochastic general equilibrium model of the financial accelerator. Consistent with empirical evidence, we find that recovery rates are pro-cyclical when collateral is costly to liquidate. Through links between recovery rates, risk premia, and default risk, the model generates an additional liquidity spiral, a feedback loop for the financial accelerator. We illustrate how collateral liquidation and monetary policy alter the impacts of a financial shock. We also show that a government subsidy on collateral liquidity and the endogenous accumulation of liquidity inventory help dampen the liquidity spiral by shoring up recovery rates
Physical Description:29 pages
ISBN:9781455201242