01898cas a2200253 a 4500 AALejournalIMF006718 230101c9999 xx r poo 0 0eng d 5.00 USD 9781455205370 1018-5941 BD-DhAAL BD-DhAAL Fostel, Ana. Why Does Bad News Increase Volatility and Decrease Leverage? / Ana Fostel, John Geanakoplos. Washington, D.C. : International Monetary Fund, 2010. 1 online resource (35 pages) IMF Working Papers <strong>Off-Campus Access:</strong> No User ID or Password Required <strong>On-Campus Access:</strong> No User ID or Password Required Electronic access restricted to authorized BRAC University faculty, staff and students The literature on leverage until now shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become volatile in bad times. Together with the old literature this explains pro-cyclical leverage. The result also gives rationale to the pattern of volatility smiles observed in the stock options since 1987. Finally, the paper presents for the first time a dynamic model in which an asset is endogenously traded simultaneously at different margin requirements in equilibrium. Mode of access: Internet Geanakoplos, John. IMF Working Papers; Working Paper ; No. 2010/206 Full text available on IMF http://elibrary.imf.org/view/journals/001/2010/206/001.2010.issue-206-en.xml IMF e-Library