The Role of Collateral in Enhancing Real Business Cycle Fluctuations.

This paper embeds collateralized borrowing into a version of the real business cycle model in which firms own capital and issue dividends to shareholders. Firms raise funds using either equity or debt, where the debt is secured by collateral. The collateral requirement is endogenously determined by the market. The one shock in the economy is an aggregate productivity shock to firms. A borrowing contract's riskiness is defined by the number of states in which default is expected in the next period. If the productivity shock does not change the riskiness of the traded borrowing contract, then leverage and productivity are inversely related.

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