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Balance Sheet Capacity and Endogenous Risk

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  • Jon Danielsson

    ()

  • Hyun Song Shin

    ()

  • Jean-Pierre Zigrand

    ()

Abstract

Banks operating under Value-at-Risk constraints give rise to a well-defined aggregate balance sheet capacity for the banking sector as a whole that depends on total bank capital. Equilibrium risk and market risk premiums can be solved in closed form as functions of aggregate bank capital. We explore the empirical properties of the model in light of recent experience in the financial crisis and highlight the importance of balance sheet capacity as the driver of the financial cycle and market risk premiums.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP665_2011_BalanceSheetCapacity.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp665.

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Date of creation: Jan 2011
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Handle: RePEc:fmg:fmgdps:dp665

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Web page: http://www.lse.ac.uk/fmg/

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  1. S. Rao Aiyagari & Mark Gertler, 1998. ""Overreaction" of Asset Prices in General Equilibrium," NBER Working Papers 6747, National Bureau of Economic Research, Inc.
  2. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
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  7. Antonio Bernardo & Ivo Welch, 2006. "Liquidity and Financial Market Runs," Yale School of Management Working Papers ysm280, Yale School of Management, revised 01 Aug 2003.
  8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  9. Basak, Suleyman & Croitoru, Benjamin, 2000. "Equilibrium Mispricing in a Capital Market with Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 715-48.
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  11. Denis Gromb & Dimitri Vayanos, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," LSE Research Online Documents on Economics 448, London School of Economics and Political Science, LSE Library.
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Cited by:
  1. Tobias Adrian & Nina Boyarchenko, 2013. "Intermediary balance sheets," Staff Reports 651, Federal Reserve Bank of New York.
  2. Monica Billio & Mila Getmansky & Andrew W. Lo & Loriana Pelizzon, 2011. "Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance Sectors," Working Papers 2011_21, Department of Economics, University of Venice "Ca' Foscari".
  3. Charles D. Brummitt & Rajiv Sethi & Duncan J. Watts, 2014. "Inside Money, Procyclical Leverage, and Banking Catastrophes," Papers 1403.1637, arXiv.org.
  4. Tobias Adrian & Nina Boyarchenko, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York.

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