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A Model of Capital and Crises

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  • Zhigu He
  • Arvind Krishnamurthy
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    Abstract

    We develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices. The model is cast within a dynamic general equilibrium economy, and the role for intermediation is derived endogenously based on optimal contracting considerations. Low intermediary capital reduces the risk-bearing capacity of the marginal investor. We show how this force helps to explain patterns during financial crises. The model replicates the observed rise during crises in Sharpe ratios, conditional volatility, correlation in price movements of assets held by the intermediary sector, and fall in riskless interest rates. Copyright 2012, Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/restud/rdr036
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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Review of Economic Studies.

    Volume (Year): 79 (2012)
    Issue (Month): 2 ()
    Pages: 735-777

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    Handle: RePEc:oup:restud:v:79:y:2012:i:2:p:735-777

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    Cited by:
    1. Mariya Gubareva & Maria Rosa Borges, 2013. "Typological Classification, Diagnostics, and Measurement of Flights-to-Quality," Working Papers Department of Economics 2013/15, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
    2. Kirstin Hubrich & Robert J. Tetlow, 2012. "Financial stress and economic dynamics: the transmission of crises," Finance and Economics Discussion Series 2012-82, Board of Governors of the Federal Reserve System (U.S.).
    3. Huang, Shiyang & Qiu, Zhigang & Shang, Qi & Tang, Ke, 2013. "Asset pricing with heterogeneous beliefs and relative performance," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4107-4119.
    4. de la Torre, Augusto & Ize, Alain, 2013. "The rhyme and reason for macroprudential policy : four guideposts to find your bearings," Policy Research Working Paper Series 6576, The World Bank.
    5. Tobias Adrian & Daniel Covitz & Nellie J. Liang, 2013. "Financial stability monitoring," Staff Reports 601, Federal Reserve Bank of New York.
    6. Sebastian Infante, 2013. "Repo collateral fire sales: the effects of exemption from automatic stay," Finance and Economics Discussion Series 2013-83, Board of Governors of the Federal Reserve System (U.S.).
    7. Itay Goldstein & Assaf Razin, 2013. "Three Branches of Theories of Financial Crises," NBER Working Papers 18670, National Bureau of Economic Research, Inc.
    8. Andrew G. Atkeson & Andrea L. Eisfeldt & Pierre-Olivier Weill, 2013. "Measuring the financial soundness of U.S. firms, 1926-2012," Staff Report 484, Federal Reserve Bank of Minneapolis.
    9. Acharya, Viral V. & Amihud, Yakov & Bharath, Sreedhar T., 2013. "Liquidity risk of corporate bond returns: conditional approach," Journal of Financial Economics, Elsevier, vol. 110(2), pages 358-386.
    10. Markus K. Brunnermeier & Martin Oehmke, 2012. "Bubbles, Financial Crises, and Systemic Risk," NBER Working Papers 18398, National Bureau of Economic Research, Inc.

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