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Wealth, endogenous collateral quality, and financial crises

Liu, Zehao and Sinclair, Andrew J. (2022) Wealth, endogenous collateral quality, and financial crises. Journal of Economic Theory, 204 . Art. No. 105526. ISSN 0022-0531. doi:10.1016/j.jet.2022.105526.

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We propose a model of collateralized lending in which (1) borrowers endogenously determine collateral quality and (2) lenders can produce costly information about collateral payoffs. Our model yields several novel predictions: wealthier economies use lower quality collateral in equilibrium, have more severe financial crises, and have less frequent crises. We provide both micro and macro empirical evidence. In the U.S. mortgage market wealthier lenders accept lower quality collateral, and, looking across countries, wealthier economies use lower quality collateral and the collateral channel explains the link between wealth and crisis severity.

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Liu, Zehao0000-0002-1510-4844
Additional Information:We thank Guillermo Ordoñez (the Editor) and two anonymous referees for constructive comments that helped improve the paper. We also thank Gary Gorton, Ping He, Zongbo Huang, Toomas Laarits, Andrew Metrick, Alexander Zentefis, and seminar participants at the Federal Reserve Board of Governors, the University of Hong Kong, Renmin University of China, and EEA Annual Congress for helpful discussions and comments. An earlier version of this paper previously circulated as “Wealth and Financial Crisis: The Collateral Channel”. Zehao Liu would like to thank the financial support from the National Natural Science Foundation of China (Grant No. 72003189).
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National Natural Science Foundation of China72003189
Record Number:CaltechAUTHORS:20220829-467858200
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Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:116616
Deposited By: Melissa Ray
Deposited On:09 Sep 2022 18:01
Last Modified:09 Sep 2022 18:01

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