A Theoretical Study Of The Imperfection Of The Credit Market And Its Economic Implication

The financial crisis in2007-2008had influence various aspects of financial and economic system. The global economy is also affected by the crisis and faces the threat of recession. The crisis makes the financial system partial paralysis and also produces devastating effects on the real economy. Defaults and corporate bankruptcies are increased dramatically in a short time. The real economy and virtual economy suffered heavy losses. Unemployment rate in the U.S. rose to a high point. However, it seems that we can always find the shadow of the credit market behind the crisis. Deterioration of the credit market, the rise of debt default rates, the burden of corporate debt, the decrease of asset prices and the increase in bankruptcy are not just the reactive to the macroeconomic downstream and they are the main factors which lead to the economic recession.The purpose of this study is to reveal the incompleteness of the credit market and its economic effects in the crisis period. The imperfections of credit market trigger the financial crisis. The innovations of the various financial instruments of the U.S. lead to the prosperity of real estate industry in a long-term before the crisis. On the one hand, the innovation of modern financial products changed the operating efficiency of credit markets greatly and at the same time stimulated the bubble of housing market in the U.S. On the other hand, the modern financial institutions rely on short-term financing heavily, but short-term financing only meet the needs of long-term risky assets investment of financial institutions partly.However, the incomplete nature of the credit markets may raise coordination problems among creditors, which makes the modern financial institutions exposed to the risk of roll over debt failure. The incomplete nature of the credit markets has increased the level of credit risk in the economy and it also reveals the vulnerability of the modern financial system. Credit market volatility has a big impact on the fluctuations of the real economy.The paper is divided into five chapters, the main contents of each chapter is organized as follows:The first chapter describes the background, purpose and the overall framework of the dissertation generally. We also report some initial results of our model. After reviewing the main contribution and drawbacks of previous literatures, we highlight the differences between those literatures with ours. Our study is a good complement to previous literatures.The second Chapter set up a theoretical model. We assume that the short-term bonds which supplied by the financial institutions is held by creditors which have two different size at the same time and when making decisions investors are often faced with multiple uncertain. Credit risk consists of illiquidity risk and insolvency risk. We build a model to study how credit risk is affected by the presence of large creditors, short-debt financing and market liquidity. Our results show:(ⅰ) an increase in the precision of the information by large creditors raises the willingness of small creditors to roll over their loans, and thereby reduces illiquidity risk;(ⅱ) a larger proportion of short-term debt financing increases illiquidity risk;(ⅲ) an increase in the market liquidity reduces illiquidity risk;(Ⅰⅴ) although the model does not find the quantitative effect of increase of institutional investors ratio on credit risk, but it show that the increase of institutional investors ratio will reduce the credit risk.The third chapter explained the prices rise of real estate in the perspective of the credit market. Previous models cannot explain continues price rising of real estate in the pre-crisis period in U.S. this section set up a searching-matching model which usually used in labor economics and use it in the credit market and the real estate market. We use this model to explain that the real estate prices rising is triggered by the credit expansion. The incomplete nature of the credit markets magnified the response of real estate price to the shock, which may explain why real estate prices have been accelerated in the pre-crisis period. At the same time, the study also found that, in some cases, when people cannot afford their debts, debt restructuring which reduce the burden of people who buy a house is social optimal choice.The fourth chapter investigates the impact of the credit risk on macroeconomic volatility. Financial crisis has raised people’s interest on the credit risk greatly, especially on that how the credit risk affect the macroeconomic volatility. There are a considerable number of empirical researches which analyze it but there is no one theoretical model which has been widely accepted. We establish a model which has endogenous credit risk in the framework of dynamic stochastic general equilibrium to investigate the impact of the credit risk on macroeconomic volatility. Specifically, this paper will draw on two most popular methods which investigate credit risk and established a bridge which link those methods. The model results show that the defaults rate of credit risk is counter-cyclical, which means the rise of default rates will reduce the level of investment and output. Credit risk will expand the response of economic to the impact, which well explains the performance of economic in the crisis period.The final chapter summarizes the main points and conclusions of the full text, make useful policy recommendations, and highlight the directions of future research.The innovation of this paper is mainly reflected in the following areas:Firstly, the theoretical study of credit market mainly focus on short-term debt financing (Morris and Shin,2004), the large short-term financing (Charles W. Charles W.,1999; Huang and Ratnovski,2011), market liquidity (Diamond and Rajan,2005; Brunnermeier of and Pedersen,2009) and the credit market freeze caused by the roll over debt (Plantin,2009; Acharya, et al.2011). However, they did not consider how those factors affect the credit risk together. This study makes up this vacancy. In addition, this study assume the situation of incomplete information and a variety of types of creditors exist which make the model richer and closer to the actual situation.Secondly, this study draws on the searching-matching modeling method which has been commonly used in labor economics and applies it to the credit market and real estate market for the first time. It explains the impact of incomplete credit market on the real estate market successfully.Thirdly, there is no one theoretical model which has been widely accepted on the incomplete of credit market and macroeconomic volatility. There are two popular methods which investigate it. One of them endogenize credit risk and give a price for credit risk, then investigate the impact of the credit risk on macroeconomic fluctuations. The other treats the financing constraints of lender as the feature of incomplete credit markets. Those two methods complement each other. The model in this dissertation draws on the advantages of both models and investigates the impact of the credit risk on the macroeconomic fluctuations. The dissertation builds a bridge between the two methods.