Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy
AbstractWe set up a model where asset price bubbles due to risk shifting can be moderated by capital requirements. However, imperfect information about the ratio of required capital, or, in the context of the sub-prime crisis, the extent of regulatory arbitrage, introduces uncertainty about the risk exposure of intermediaries. Underestimation of regulatory arbitrage may induce households to infer that higher asset prices are due to a decline of risk. First, this mechanism can explain why the risk premia paid by US financial intermediaries did not increase between 2000 and 2007 in spite of its increasing leverage. Second, we provide a theory of the risk taking channel of monetary policy: in the model, the underestimation of risk is larger the lower the level of the risk free interest rate.
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Bibliographic InfoPaper provided by Banque de France in its series Working papers with number 254.
Length: 35 pages
Date of creation: 2009
Date of revision:
Capital requirements; Imperfect Information; Risk-taking Channel of monetary policy.;
Find related papers by JEL classification:
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-11-07 (All new papers)
- NEP-CBA-2009-11-07 (Central Banking)
- NEP-MAC-2009-11-07 (Macroeconomics)
- NEP-MON-2009-11-07 (Monetary Economics)
- NEP-UPT-2009-11-07 (Utility Models & Prospect Theory)
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