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Financial intermediary leverage and value at risk

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Author Info
Tobias Adrian
Hyun Song Shin

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Abstract

We study a contracting model for the determination of leverage and balance sheet size for financial intermediaries that fund their activities through collateralized borrowing. The model gives rise to two features: First, leverage is procyclical in the sense that leverage is high when the balance sheet is large. Second, leverage and balance sheet size are both determined by the riskiness of assets. For U.S. investment banks, we find empirical support for both features of our model, that is, leverage is procyclical, and both leverage and balance sheet size are determined by measured risks. In a system context, increased risk reduces the debt capacity of the financial system as a whole, giving rise to amplified de-leveraging by institutions by way of the chain of repo transactions in the financial system.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 338.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:338

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Related research
Keywords: Financial leverage ; Financial risk management ; Assets (Accounting) ; Repurchase agreements ; Bank liquidity;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 3-21, January. [Downloadable!] (restricted)
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  3. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
  4. Nobuhiro Kiyotaki & John Moore, 2002. "Balance-Sheet Contagion," American Economic Review, American Economic Association, vol. 92(2), pages 46-50, May. [Downloadable!]
  5. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Lasse Heje Pederson & Markus K Brunnermeier, 2007. "Market Liquidity and Funding Liquidity," FMG Discussion Papers dp580, Financial Markets Group. [Downloadable!] (restricted)
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  7. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 37-68. [Downloadable!] (restricted)
  8. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June. [Downloadable!] (restricted)
  9. Markus K. Brunnermeier, 2008. "Deciphering the Liquidity and Credit Crunch 2007-08," NBER Working Papers 14612, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July. [Downloadable!] (restricted)
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  11. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October. [Downloadable!] (restricted)
  12. Chiesa, Gabriella, 2001. "Incentive-Based Lending Capacity, Competition and Regulation in Banking," Journal of Financial Intermediation, Elsevier, vol. 10(1), pages 28-53, January. [Downloadable!] (restricted)
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  13. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity, monetary policy, and financial cycles," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Jan. [Downloadable!]
  14. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York. [Downloadable!]
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Tobias Adrian & Markus K. Brunnermeier, 2008. "CoVaR," Staff Reports 348, Federal Reserve Bank of New York. [Downloadable!]
  2. Douglas W. Diamond & Raghuram G. Rajan, 2009. "Fear of Fire Sales and the Credit Freeze," NBER Working Papers 14925, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York. [Downloadable!]
  4. Andrei Shleifer & Robert W. Vishny, 2009. "Unstable Banking," NBER Working Papers 14943, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Peter Stella, 2009. "The Federal Reserve System Balance Sheet-What Happened and Why it Matters," IMF Working Papers 09/120, International Monetary Fund. [Downloadable!]
  6. David B. Brown & Bruce Ian Carlin & Miguel Sousa Lobo, 2009. "On the Scholes Liquidation Problem," NBER Working Papers 15381, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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