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A model of leverage based on risk sharing

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  • Wang, Tianxi
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    Abstract

    This paper offers a new approach, based on risk sharing, to endogenize the leverage of financial intermediaries. It endogenizes debt as the optimal contract for external financing, thereby capturing two features of leverage: debt serves to boost the return on equity, and equity provides “safety net” for debt. The paper derives a novel prediction that when the asset-side risk rises, the leverage ratio is reduced, but the profit margin of leveraging is actually widened.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0165176513000621
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    Bibliographic Info

    Article provided by Elsevier in its journal Economics Letters.

    Volume (Year): 119 (2013)
    Issue (Month): 1 ()
    Pages: 97-100

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    Handle: RePEc:eee:ecolet:v:119:y:2013:i:1:p:97-100

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    Web page: http://www.elsevier.com/locate/ecolet

    Related research

    Keywords: Risk sharing; Leverage; Financial intermediaries;

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    1. Douglas Gale & Onur Özgür, 2005. "Are Bank Capital Ratios too High or too Low? Incomplete Markets and Optimal Capital Structure," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 690-700, 04/05.
    2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    3. Gary Gorton & Andrew Metrick, 2009. "Securitized Banking and the Run on Repo," Yale School of Management Working Papers amz2358, Yale School of Management, revised 01 Sep 2009.
    4. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
    5. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
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