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Systemic risk-taking: amplification effects, externalities, and regulatory responses

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  • Korinek, Anton

Abstract

This paper analyzes the efficiency of risk-taking decisions in an economy that is prone to systemic risk, captured by financial amplification effects that occur in response to strong adverse shocks. It shows that decentralized agents who have unconstrained access to a complete set of Arrow securities choose to expose themselves to such risk to a socially inefficient extent because of pecuniary externalities that are triggered during financial amplification. The paper develops an externality pricing kernel that quantifies the state-contingent magnitude of such externalities and provides welfaretheoretic foundations for macro-prudential policy measures to correct the distortion. Furthermore, it derives conditions under which agents employ ex-ante risk markets to fully undo any expected government bailout. Finally, it finds that constrained market participants face socially insufficient incentives to raise more capital during episodes of financial amplification. JEL Classification: E44, G13, G18, D62, H23

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1345.

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Date of creation: Jun 2011
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Handle: RePEc:ecb:ecbwps:20111345

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Related research

Keywords: bailout neutrality; externality pricing kernel; financial amplification; macroprudential regulation; systemic externalities; systemic risk;

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Cited by:
  1. Jeanne, O. & Korinek, A., 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," Discussion Paper, Tilburg University, Center for Economic Research 2010-108S, Tilburg University, Center for Economic Research.
  2. Liu, Luke, 2011. "Asset price, asset securitization and financial stability," MPRA Paper 35000, University Library of Munich, Germany.
  3. Tommaso Trani, 2012. "Countercyclical Capital Regulation and Bank Ownership Structure," IHEID Working Papers, Economics Section, The Graduate Institute of International Studies 14-2012, Economics Section, The Graduate Institute of International Studies.
  4. Anton Korinek, 2011. "Hot Money and Serial Financial Crises," IMF Economic Review, Palgrave Macmillan, Palgrave Macmillan, vol. 59(2), pages 306-339, June.
  5. Paolo Angelini & Sergio Nicoletti-Altimari & Ignazio Visco, 2012. "Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs," Questioni di Economia e Finanza (Occasional Papers) 140, Bank of Italy, Economic Research and International Relations Area.
  6. Brixiova, Zuzana & Vartia, Laura & Wörgötter, Andreas, 2010. "Capital flows and the boom-bust cycle: The case of Estonia," Economic Systems, Elsevier, vol. 34(1), pages 55-72, March.
  7. Christian Fahrholz & Andreas Freytag, 2012. "Will TARGET2-Balances be Reduced again after an End of the Crisis?," Global Financial Markets Working Paper Series 30-2012, Friedrich-Schiller-University Jena.
  8. Gustavo Abarca & Claudia Ramírez & José Gonzalo Rangel, 2012. "Capital Controls and Exchange Rate Expectations in Emerging Markets," Working Papers 2012-08, Banco de México.
  9. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2012. "How to Calculate Systemic Risk Surcharges," NBER Chapters, in: Quantifying Systemic Risk, pages 175-212 National Bureau of Economic Research, Inc.
  10. Viral V. Acharya & Matthew Richardson, 2012. "Implications of the Dodd-Frank Act," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 1-38, October.
  11. Joseph E. Stiglitz, 2011. "Rethinking Macroeconomics: What Failed, And How To Repair It," Journal of the European Economic Association, European Economic Association, European Economic Association, vol. 9(4), pages 591-645, 08.
  12. Tobias Adrian & Markus K. Brunnermeier, 2008. "CoVaR," Staff Reports 348, Federal Reserve Bank of New York.
    • Tobias Adrian & Markus K. Brunnermeier, 2011. "CoVaR," NBER Working Papers 17454, National Bureau of Economic Research, Inc.
  13. Adrian, Tobias & Etula, Erkko & Groen, Jan J.J., 2011. "Financial amplification of foreign exchange risk premia," European Economic Review, Elsevier, vol. 55(3), pages 354-370, April.
  14. Segura, Anatoli & Suarez, Javier, 2011. "Liquidity shocks, roll-over risk and debt maturity," CEPR Discussion Papers 8324, C.E.P.R. Discussion Papers.
  15. Guembel, Alexander & Sussman, Oren, 2010. "Liquidity, Contagion and Financial Crisis," IDEI Working Papers 664, Institut d'Économie Industrielle (IDEI), Toulouse.
  16. Aizenman, Joshua, 2011. "Hoarding international reserves versus a Pigovian tax-cum-subsidy scheme: Reflections on the deleveraging crisis of 2008-2009, and a cost benefit analysis," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(9), pages 1502-1513, September.
  17. Michael Keen, 2011. "The Taxation and Regulation of Banks," IMF Working Papers 11/206, International Monetary Fund.
  18. Gunther Tichy, 2010. "War die Finanzkrise vorhersehbar?," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 11(4), pages 356-382, November.
  19. David Mayes, 2011. "The future of financial markets: financial crisis avoidance," Empirica, Springer, Springer, vol. 38(1), pages 77-101, February.

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