This paper combines the manuscripts "Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses" by Anton Korinek (2011) and "Dissecting Fire Sales Externalities" by Eduardo Dávila (2014). An earlier version of the combined manuscript was circulated under the title "Fire-Sale Externalities." We thank our editor, Dimitri Vayanos, and three anonymous referees for their guidance and insightful comments. We are also greatly indebted to participants at numerous conference and seminar presentations who have provided many helpful comments. Korinek is grateful for financial support from the Lamfalussy Fellowship of the ECB, the Institute for New Economic Thinking, and the NFI. Dávila is grateful for financial support from the Rafael del Pino Foundation. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

This paper combines the manuscripts "Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses" by Anton Korinek (2011) and "Dissecting Fire Sales Externalities" by Eduardo Dávila (2014). An earlier version of the combined manuscript was circulated under the title "Fire-Sale Externalities." We thank our editor, Dimitri Vayanos, and three anonymous referees for their guidance and insightful comments. We are also greatly indebted to participants at numerous conference and seminar presentations who have provided many helpful comments. Korinek is grateful for financial support from the Lamfalussy Fellowship of the ECB, the Institute for New Economic Thinking, and the NFI. Dávila is grateful for financial support from the Rafael del Pino Foundation. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w24091.ack NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

We study the relationship between homebuyers’ beliefs about future house price changes and their mortgage leverage choices. Whether more pessimistic homebuyers choose higher or lower leverage depends on their willingness and ability to reduce the size of their housing market investments. When households primarily maximize the levered return of their property investments, more pessimistic homebuyers reduce their leverage to purchase smaller houses. On the other hand, when considerations such as family size pin down the desired property size, pessimistic homebuyers reduce their financial exposure to the housing market by making smaller downpayments to buy similarly-sized homes. To determine which scenario better describes the data, we investigate the cross-sectional relationship between house price beliefs and mortgage leverage choices in the U.S. housing market. We use plausibly exogenous variation in house price beliefs to show that more pessimistic homebuyers make smaller downpayments and choose higher leverage, in particular in states where default costs are relatively low, as well as during periods when house prices are expected to fall on average. Our results highlight the important role of heterogeneous beliefs in explaining households’ financial decisions.

provided outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.N BER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

provided outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.N BER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

This article studies the optimal determination of bankruptcy exemptions for risk averse borrowers who use unsecured contracts but have the possibility of defaulting. In a large class of economies, knowledge of four variables is sufficient to determine whether a bankruptcy exemption level is optimal or should be increased or decreased. These variables are 1. the composition of households’ liabilities, 2. the sensitivity of the credit supply schedule to exemption changes, 3. the probability of filing for bankruptcy with non-exempt assets, and 4. the value given by households to a marginal dollar in different states, which can be mapped to changes in households’ consumption. I recover empirical estimates of the sufficient statistics using U.S. data over the period 2008–16 and find that increasing exemption levels improves overall welfare, although there is substantial variation in estimated welfare gains across U.S. states and income quintiles.

No abstract