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A model of leverage based on risk sharing

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  • Wang, Tianxi

Abstract

This paper offers a new approach, based on risk sharing, to endogenize the leverage of financial intermediaries. It endogenizes debt as the optimal contract for external financing, thereby capturing two features of leverage: debt serves to boost the return on equity, and equity provides “safety net” for debt. The paper derives a novel prediction that when the asset-side risk rises, the leverage ratio is reduced, but the profit margin of leveraging is actually widened.

Suggested Citation

  • Wang, Tianxi, 2013. "A model of leverage based on risk sharing," Economics Letters, Elsevier, vol. 119(1), pages 97-100.
  • Handle: RePEc:eee:ecolet:v:119:y:2013:i:1:p:97-100 DOI: 10.1016/j.econlet.2013.02.001
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    References listed on IDEAS

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    1. Douglas Gale & Onur Özgür, 2005. "Are Bank Capital Ratios too High or too Low? Incomplete Markets and Optimal Capital Structure," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 690-700, 04/05.
    2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, pages 2201-2238.
    3. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
    4. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    5. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-1244, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Risk sharing; Leverage; Financial intermediaries;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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