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Collateralized Borrowing and Risk Taking at Low Interest Rates?

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Abstract

A view advanced in the aftermath of the late-2000s fi?nancial crisis is that lower than optimal interest rates lead to excessive risk taking by fi?nancial intermediaries. We evaluate this view in a quantitative dynamic model where interest rate policy affects risk taking through two channels. First, policy influences the attractiveness of safe bond investments relative to riskier assets. Moreover, policy changes the amount of safe bonds available for collateralized borrowing in interbank markets. In this framework, collateral constraints provide a safeguard against increases in risk taking. Lower than optimal policy rates lead to tighter collateral constraints and reduce risk taking.

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File URL: http://economics.uwo.ca/epri/workingpapers_docs/wp2012/Cociuba_Shukayev_Ueberfeldt_01.pdf
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Bibliographic Info

Paper provided by University of Western Ontario, Economic Policy Research Institute in its series University of Western Ontario, Economic Policy Research Institute Working Papers with number 20121.

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Date of creation: 2012
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Handle: RePEc:uwo:epuwoc:20121

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Postal: Economic Policy Research Institute, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2
Phone: 519-661-2111 Ext.85244
Web page: http://economics.uwo.ca/research/research_papers/epri_workingpapers.html

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Keywords: financial intermediation; risk taking; optimal interest rate policy;

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References

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  1. Arvind Krishnamurthy & Stefan Nagel & Dmitry Orlov, 2012. "Sizing Up Repo," NBER Working Papers 17768, National Bureau of Economic Research, Inc.
  2. Delis, Manthos D. & Kouretas, Georgios P., 2011. "Interest rates and bank risk-taking," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 840-855, April.
  3. Eisfeldt, Andrea L. & Rampini, Adriano A., 2006. "Capital reallocation and liquidity," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 369-399, April.
  4. Harding, Don & Pagan, Adrian, 2002. "Dissecting the cycle: a methodological investigation," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 365-381, March.
  5. DellAriccia, Giovanni & Laeven, Luc & Marquez, Robert, 2011. "Monetary Policy, Leverage, and Bank Risk-taking," CEPR Discussion Papers 8199, C.E.P.R. Discussion Papers.
  6. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.
  7. Peter Hördahl & Michael R King, 2008. "Developments in repo markets during the financial turmoil," BIS Quarterly Review, Bank for International Settlements, December.
  8. Giovanni Dell'Ariccia, 2010. "Monetary Policy and Bank Risk-Taking," IMF Staff Position Notes 2010/09, International Monetary Fund.
  9. Ioannidou, V. & Ongena, S. & Peydro, J.L., 2009. "Monetary Policy, Risk-Taking, and Pricing: Evidence from a Quasi-Natural Experiment," Discussion Paper 2009-31 S, Tilburg University, Center for Economic Research.
  10. Itai Agur & Maria Demertzis, 2010. "Monetary Policy and Excessive Bank Risk Taking," DNB Working Papers 271, Netherlands Central Bank, Research Department.
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Cited by:
  1. Malik Shukayev & Alexander Ueberfeldt & Simona Cociuba, 2013. "Interest Rate Policy and Financial Regulation: How to Control Excessive Risk Taking?," 2013 Meeting Papers 584, Society for Economic Dynamics.
  2. Drees, Burkhard & Eckwert, Bernhard & Várdy, Felix, 2013. "Cheap money and risk taking: Opacity versus fundamental risk," European Economic Review, Elsevier, vol. 62(C), pages 114-129.
  3. Itai Agur & Maria Demertzis, 2013. ""Leaning Against the Wind" and the Timing of Monetary Policy," IMF Working Papers 13/86, International Monetary Fund.

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