Abstract :
Duringfinancialturmoil,increasesinriskleadtohigherdefault,foreclosure,andfire
sales.Thispaperintroducesacostlyliquidationprocessforforeclosedcollateraland
pro-cyclicalrecoveryratesinadynamicstochasticgeneralequilibriummodelofthe
financialaccelerator.Linksbetweenendogenousrecoveryrates,riskpremia,anddefault
risk generatealiquidityspiral,magnifyingfinancialacceleratoreffects.Weillustrate
how collateralliquidationandmonetarypolicyaltertherealimpactoffinancialshocks
operatingthroughmacro-financiallinkages;andthewayagovernmentsubsidyon
collateralliquidityandrequiredliquiditybufferscanhelpdampentheliquidityspiral
by shoringuprecoveryrates
