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Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy

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  • Dubecq, S.
  • Mojon, B.
  • Ragot, X.

Abstract

We 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 Info

Paper provided by Banque de France in its series Working papers with number 254.

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Length: 35 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:bfr:banfra:254

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Keywords: Capital requirements; Imperfect Information; Risk-taking Channel of monetary policy.;

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References

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  1. Gadi Barlevy, 2011. "A leverage-based model of speculative bubbles," Working Paper Series WP-2011-07, Federal Reserve Bank of Chicago.
  2. Emmanuel Farhi & Jean Tirole, 2012. "Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts," American Economic Review, American Economic Association, vol. 102(1), pages 60-93, February.
  3. Challe Edouard & Ragot Xavier, 2011. "Bubbles and Self-Fulfilling Crises," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-38, May.
  4. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  5. Hamerle, Alfred & Liebig, Thilo & Rösch, Daniel, 2003. "Credit Risk Factor Modeling and the Basel II IRB Approach," Discussion Paper Series 2: Banking and Financial Studies 2003,02, Deutsche Bundesbank, Research Centre.
  6. repec:pse:psecon:2005-44 is not listed on IDEAS
  7. Ciccarelli, Matteo & Peydró, José-Luis & Maddaloni, Angela, 2010. "Trusting the bankers: a new look at the credit channel of monetary policy," Working Paper Series 1228, European Central Bank.
  8. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
  9. Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-55, January.
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