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Federal Reserve Bank of Richmond
Working Paper
Asset Pledgeability and Endogenously Leveraged Bubbles
Julien Bengui
Toan Phan

We develop a simple model of defaultable debt and rational bubbles in the price of an asset, which can be pledged as collateral in a competitive credit pool. When the asset pledgeability is low, the down payment is high, and bubble investment is unleveraged, as in a standard rational bubble model. When the pledgeability is high, the down payment is low, making it easier for leveraged borrowers to invest in the bubbly asset. As loans are packaged together into a competitive pool, the pricing of individual default risk may facilitate risk-taking. In equilibrium, credit-constrained borrowers may optimally choose a risky leveraged investment strategy – borrow to invest in the bubbly asset and default if the bubble bursts. The model predicts joint boom-bust cycles in asset prices and securitized credit.

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Julien Bengui & Toan Phan, Asset Pledgeability and Endogenously Leveraged Bubbles, Federal Reserve Bank of Richmond, Working Paper 18-11, 19 Apr 2018.
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Keywords: rational bubbles; collateral; credit pool; household debt; equilibrium default
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