What Happens When You Regulate Risk? Evidence from a Simple Equilibrium Model
AbstractThe implications of Value-at-Risk regulations are analyzed in a CARA-normal general equilibrium model. Financial institutions are heterogeneous in risk preferences, wealth and the degree of supervision. Regulatory risk constraints lower the probability of one form of a systemic crisis, at the expense of more volatile asset prices, less liquidity, and the amplification of downward price movements. This can be viewed as a consequence of the endogenously changing risk appetite of financial institutions induced by the regulatory constraints. Finally, the Value-at-Risk constraints may prevent market clearing altogether. The role of unregulated institutions (hedge-funds) is considered. The findings are illustrated with an application to the 1987 and 1998 crises.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp393.
Date of creation: Oct 2001
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- Jean-Pierre Zigrand & Jon Danielsson, 2001. "What happens when you regulate risk?: evidence from a simple equilibrium model," LSE Research Online Documents on Economics 25069, London School of Economics and Political Science, LSE Library.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
- G20 - Financial Economics - - Financial Institutions and Services - - - General
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