Wealth and Financial Crises : The Collateral Channel

Wealthier economies experience less frequent but more severe financial crises. To investigate this puzzle, we propose a model of collateralized lending in which: (1) borrowers endogenously determine collateral quality, and (2) lenders can produce costly information about collateral. In equilibrium, lenders do not produce information and borrowers in wealthier economies optimally use lower quality collateral. Crises are triggered by unexpected shocks to collateral quality. Wealthier economies experience more severe crises because collateral quality is ex ante lower, and experience less frequent crises because borrowers have larger incentives to bailout collateral. We examine the implications of our model in a country-year panel and find supporting evidence