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Financial Risk Capacity

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  • Saki Bigio

    (New York University)

Abstract

Financial crises appear to persist if banks fail to be recapitalized quickly after large losses. I explain this impediment through a model where banks provide intermediation services in asset markets with informational asymmetries. Intermediation is risky because banks take positions over assets under disadvantageous information. Large losses reduce bank net worth and, therefore, the capacity to bear further losses. Losing this capacity leads to reductions in intermediation volumes that exacerbate adverse selection. Adverse selection, in turn, lowers bank prots which explains the failure to attract new equity. These financial crises are characterized by a depression in economic growth that is overcome only as banks slowly strengthen by retaining earnings. The model is calibrated and used to analyze several policy interventions.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 97.

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Date of creation: 2012
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Handle: RePEc:red:sed012:97

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Cited by:
  1. Javier Bianchi, 2012. "Efficient bailouts?," Globalization and Monetary Policy Institute Working Paper 133, Federal Reserve Bank of Dallas.
  2. Joseph Mullins & Gaston Navarro & Julio Blanco, 2013. "Equilibrium Default and Slow Recoveries," 2013 Meeting Papers 694, Society for Economic Dynamics.
  3. Mark Gertler & Nobuhiro Kiyotaki, 2013. "Banking, Liquidity and Bank Runs in an Infinite Horizon Economy," 2013 Meeting Papers 59, Society for Economic Dynamics.
  4. Zhiguo He & Arvind Krishnamurthy, 2012. "A macroeconomic framework for quantifying systemic risk," Working Paper Research 233, National Bank of Belgium.

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