Financial intermediary leverage and value at risk
AbstractWe 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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Bibliographic InfoPaper provided by Federal Reserve Bank of New York in its series Staff Reports with number 338.
Date of creation: 2008
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ACC-2008-09-05 (Accounting & Auditing)
- NEP-ALL-2008-09-05 (All new papers)
- NEP-BAN-2008-09-05 (Banking)
- NEP-BEC-2008-09-05 (Business Economics)
- NEP-RMG-2008-09-05 (Risk Management)
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