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Lecture 25 - The Leverage Cycle and the Subprime Mortgage Crisis

Lecture 25 - The Leverage Cycle and the Subprime Mortgage Crisis

This video was recorded at YALE - ECON 251 - Financial Theory. Standard financial theory left us woefully unprepared for the financial crisis of 2007-09. Something is missing in the theory. In the majority of loans the borrower must agree on an interest rate and also on how much collateral he will put up to guarantee repayment. The standard theory presented in all the textbooks ignores collateral. The next two lectures introduce a theory of the Leverage Cycle, in which default and collateral are endogenously determined. The main implication of the theory is that when collateral requirements get looser and leverage increases, asset prices rise, but then when collateral requirements get tougher and leverage decreases, asset prices fall. This stands in stark contrast to the fundamental value... Show More
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