Belief Disagreements and Collateral Constraints

By Alp Simsek. 2013

271 citations recorded by the source corpus.

Belief disagreements have been suggested as a major contributing factor to the recent financial crisis. This paper theoretically evaluates this hypothesis. I assume that optimists have limited wealth and take on leverage in order to take positions in line with their beliefs. To have a significant effect on asset prices, they need to borrow from traders with pessimistic beliefs using loans collateralized by the asset itself. Since pessimists do not value the collateral as much as optimists do, they are reluctant to lend, which provides an endogenous constraint on optimist's ability to borrow and to influence asset prices. I demonstrate that the tightness of this constraint depends on the nature of belief disagreements. Optimism concerning the probability of downside states has no or little effect on asset prices because these types of optimism are disciplined by this constraint. Instead, optimism concerning the relative probability of upside states could have significant effects on asset prices. This asymmetric disciplining effect is robust to allowing for short selling because pessimists that borrow the asset face a similar endogenous constraint. These results emphasize that what investors disagree about matters for asset prices, to a greater extent than the level of disagreements. When richer contracts are available, insurance contracts (similar to credit default swaps) endogenously emerge to facilitate betting. Richer contracts moderate the effect of belief disagreements on asset prices because the medium of betting shifts from buying (or shorting) the asset to trading alternative contracts.

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/faec082d1916bf6c673607dbb5428844b8a96d61

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Citations in the corpus

Macroeconomics with Financial Frictions: A Survey (2012, unknown): “Simsek (2010) stresses that the distortions are limited in a setting in which the payoff of the collateral asset can take on many values, since each optimisit has to borrow from the pessimist who value the collateral asset less.”
Credit Supply and Housing Speculation (2018, unknown): “Indeed, models in which credit availability affects asset prices often assume heterogeneity in beliefs about future asset values (e.g., Geanakoplos (2010) and Simsek (2013)).”
Credit-Market Sentiment and the Business Cycle (2017, unknown): “Now consider an alternative story along the lines of Rognlie, Shleifer, and Simsek (2016): General investor over-optimism at time t−2 leads to over-investment in some sectors, and it is this inefficient investment—for example, an excess supply of housing units or of capital in certain industries— ra”
Learning from History: Volatility and Financial Crises (2016, background): “In the model of Simsek (2013), optimism related to the relative probability of upside states increases asset valuations and the ability of agents to increase credit in the economy.”
A Welfare Criterion For Models With Distorted Beliefs (2014, background): “In this case, a trade-off arises between the welfare gain from risk sharing and the welfare loss from speculative trading (see, e.g., Kubler and Schmedders (2012), Simsek (2013a), and Posner and Weyl (2013)).”
Collateral Equilibrium: A Basic Framework (2014, background): “See Barrett (2000) and Simsek (2013) for models in which forecasts/beliefs might be incorrect/different.”
House Price Beliefs And Mortgage Leverage Choice (2017, methodology): “As a reader explained to the Washington Post (2011): “An acquaintance once told me he doesn’t believe in putting much money down on a mortgage loan because that way he can ‘just walk away’ if things ever get bad.”