Monday, January 18, 2010

Leverage Cycle And Wealth Distribution

I read "John Geanakoplos on the Leverage Cycle" by Rajiv Sethi, the professor of economics at Columbia university, today (my emphasis):
The latest paper in the sequence is The Leverage Cycle, to be published later this year in the NBER Macroeconomics Annual. Among the many insights contained there is the following: the price of an asset at any point in time is determined not simply by the stream of revenues it is expected to yield, but also by the manner in which wealth is distributed across individuals with varying beliefs, and the extent to which these individuals have access to leverage. As a result, a relatively modest decline in expectations about future revenues can result in a crash in asset prices because of two amplifying mechanisms: changes in the degree of equilibrium leverage, and the bankruptcy of those who hold the most optimistic beliefs.

Link it to this story and the compilation of links by Steve Randy Waldman at Interfluidity ...

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