Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/120427 
Authors: 
Year of Publication: 
2015
Series/Report no.: 
IES Working Paper No. 5/2015
Publisher: 
Charles University in Prague, Institute of Economic Studies (IES), Prague
Abstract: 
This paper suggests that non-fundamental component in asset prices is one of the drivers of financial and credit cycle. Presented model builds on the financial accelerator literature by including a stock market where limitedly-liable investors trade stocks of productive firms with stochastic productivities. Investors borrow funds from the banking sector and can go bankrupt. Their limited liability induces a moral hazard problem which shifts demand for risk and drives prices of risky assets above fundamental value. Embedding the contracting problem in a New Keynesian general equilibrium framework, the model shows that loose monetary policy induces loose credit conditions and leads to a rise in both fundamental and nonfundamental components of stock prices. Positive shock to non-fundamental component triggers a financial cycle: collateral values rise, lending rate and default rate decreases. These effects reverse after several quarters, inducing a credit crunch. The credit boom lasts only while stock market growth maintains sufficient momentum. However, monetary policy does not reduce volatility of inflation and output gap by reacting to asset prices.
Subjects: 
credit cycle
limited liability
non-fundamental asset pricing
collateral value
monetary policy
JEL: 
E32
E44
E52
G10
Document Type: 
Working Paper

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