Procyclicality, collateral values and financial stability
AbstractThis paper analyses how the risk-sharing capacity of the financial system varies over the business cycle, leading to procyclical fragility. We show how financial imperfections contribute to underinsurance by entrepreneurs, generating an externality that leads to the build-up of systematic risk during upturns. Increased asset price uncertainty emerges as a symptom of the sectoral concentration that builds up during booms. The liquidity of the collateral asset is shown to play a key role in amplifying the financial cycle. The welfare costs of financial stability, in terms of the efficiency costs due to financial frictions and the volatility costs due to amplification, are also illustrated.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 304.
Date of creation: Aug 2006
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-09-30 (All new papers)
- NEP-DGE-2006-09-30 (Dynamic General Equilibrium)
- NEP-ENT-2006-09-30 (Entrepreneurship)
- NEP-FMK-2006-09-30 (Financial Markets)
- NEP-MAC-2006-09-30 (Macroeconomics)
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