tag:blogger.com,1999:blog-4039434.post5921694465730729939..comments2024-02-26T06:46:53.171-05:00Comments on Rajiv Sethi: John Geanakoplos on the Leverage CycleRajivhttp://www.blogger.com/profile/13667685126282705505noreply@blogger.comBlogger2125tag:blogger.com,1999:blog-4039434.post-4203951342332171102010-01-19T11:47:50.474-05:002010-01-19T11:47:50.474-05:00They lend money that is secured by the collateral....They lend money that is secured by the collateral. Even if they believe that the collateral value will decline, it makes sense for them to do so as long as they don't lend too much - that is, if the margin is sufficiently high. Similarly, a broker would happily lend to an investor even if he believes that the resulting purchase is misguided, as long as the loan is small enough relative to the value of shares purchased. I don't really see the problem here.Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-16065175400845835562010-01-19T09:11:34.126-05:002010-01-19T09:11:34.126-05:00Prof. Sethi,
The 'higher asset price due to l...Prof. Sethi,<br /><br />The 'higher asset price due to leverage' seems to require a key behavioural idiosyncrasy - those pessimistic about the mortgages will nevertheless lend money to those optimistic about them to make the exact same purchase that they would have avoided. I understand that in a more complex model with multiple assets, the argument will not be as stark, but the crux of the logic will remain. While this may indeed happen to an extent, it is doubtful if this will be the key driver of asset prices in a bubble all by itself.<br /><br />Of course, securitization, model errors resulting from underestimating correlation (and hence overestimating the benefits of diversification)and rating arbitrage make it a more significant effect than it otherwise would have been.Ritwikhttps://www.blogger.com/profile/00616694597577112758noreply@blogger.com