ASSET PRICING MODEL: Coordination failures 3


The reinvestment cost is p + e, where p > 0 and e is the price of commercial real estate. Letting et and ед denote the commercial real estate prices in the bad and good states, the overall liquidity need is then
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Commercial real estate construction is part of the initial invesment. Each firm buys one unit of real estate per unit of investment. Firms invest this amount in commercial real estate at date 0 because they want to stand ready to produce at least in the good state.

On the consumer side, we return to our basic paradigm in which preferences are linear: cq + c\ + C2.
Divested real estate is costlessly converted into residential real estate on a one-to-one basis, say. To make our main point in the starkest way, suppose that there is a fixed (residual) demand at price v; the absorption capacity of the residential real estate market is г. That is, if less than г units of commercial real estate is converted, the price on the residential real estate market is v; if more than г is converted, there is excess supply and the price on that market drops to 0. Assume that
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Again, there are two possible equilibria:

• Low-price, low-production equilibrium:

Suppose that in the bad state the corporate sector dumps all its commercial real estate onto the residential market. The price drops to 0, and since there is no other liquid asset besides real estate all firms are liquidated. Even though the commercial real estate is now free, firms are unable to continue.

• High-price, high-production equilibrium:

Suppose instead that only a fraction I of the assets are liquidated, where
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Conditions (37) and (38) imply that z < z, and so the market price of real estate is v. The corporate sector thus has total available liquidity per unit of investment equal to v, and can finance the shortfall p + v on a fraction 1 — 2 of its assets. castle payday loans

In this equilibrium, consumers pay higher date-1 prices for residential real estate and the restraint on sales provides insurance to the corporate sector against full credit rationing at date l.29 Such insurance raises ex ante social surplus.

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