Risk, Leverage, and Regulation of Financial Intermediaries
AbstractThis paper presents a model on the leverage of financial intermediaries, where debt are held by risk averse agents and equity by the risk neutral. The paper shows that in an unregulated competitive market, financial intermediaries choose to be leveraged over the social best level. This is because the leverage of one intermediary imposes a negative externality upon others by reducing their profit margins. The paper thus founds capital adequacy regulation upon the market failure and suggests that this regulation should bind not only commercial banks, but all financial intermediaries, including private equities and hedge funds.
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Bibliographic InfoPaper provided by University of Essex, Department of Economics in its series Economics Discussion Papers with number 678.
Date of creation: 03 Nov 2009
Date of revision:
Postal: Discussion Papers Administrator, Department of Economics, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, U.K.
Other versions of this item:
- Tianxi, Wang, 2009. "Risk, Leverage, and Regulation of Financial Intermediaries," MPRA Paper 18212, University Library of Munich, Germany.
- D62 - Microeconomics - - Welfare Economics - - - Externalities
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
- G00 - Financial Economics - - General - - - General
- G01 - Financial Economics - - General - - - Financial Crises
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