|Researchers:||Paul Gortner, Baptiste Massenot|
|Category:||Macro Finance, Financial Intermediation, Law and Finance, Financial Markets, Experiment Center|
This project was part of the team project "Social Finance – Finance and the Consumer".
Topic and Objectives
In this paper, we further explore the relationship between leverage and bubbles in an asset market experiment. We consider two channels through which higher leverage may produce larger bubbles. First, higher leverage limits downside risk in case of limited liability, which should increase the willing to pay for assets and fuel bubbles (the moral hazard channel). Second, higher leverage may be associated with higher aggregate liquidity, which may also increase the demand for assets and exert upward pressure on prices (the liquidity channel).
We first test the moral hazard channel by conducting an asset market experiment in which traders have to repay debt at the end of the experiment and in which aggregate liquidity stays constant. By varying the level of debt, we can then investigate whether leverage has an impact on trader behavior and asset price bubbles. We then test the liquidity channel by studying a setup in which we inject or withdraw liquidity in the economy to maintain leverage constant over time.
- With fixed liquidity, higher leverage does not produce larger bubbles and more leveraged participants trade more cautiously by paying lower prices and buying fewer assets.
- To understand this unexpected result, we run the same experiment with a different framing: instead of repaying debt, participants can earn a bonus. This bonus treatment produces larger bubbles, suggesting that more leveraged participants trade more cautiously to avoid default.
- Finally, when we inject liquidity in the economy to maintain leverage constant over time, bubbles are larger and increase over time, suggesting that higher leverage may fuel bubbles because it increases aggregate liquidity.
|Rainer Haselmann, David Schoenherr, Vikrant Vig||
Rent-Seeking in Elite Networks
Journal of Political Economy
|2018||Macro Finance, Financial Intermediation, Law and Finance, Financial Markets, Experiment Center||-|
|239||Paul Gortner, Baptiste Massenot||Leverage and Bubbles: Experimental Evidence||2018||Macro Finance, Financial Intermediation, Law and Finance, Financial Markets, Experiment Center|