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Risk Shifting with Fuzzy Capital Constraints

Author

Listed:
  • Simon Dubecq

    (European Central Bank)

  • Benoit Mojon

    (Banque de France)

  • Xavier Ragot

    (CNRS - Paris School of Economics)

Abstract

We construct a model where risk shifting can be moderated by capital requirements. Imperfect information about the level of capital per unit of risk, however, introduces uncertainty about the risk exposure of intermediaries. Over-estimation of the capital held by financial intermediaries, or the extent of regulatory arbitrage, may induce households to wrongly infer from higher asset prices that the fundamentals of risky assets have improved. This mechanism can notably explain the low risk premia paid by U.S. financial intermediaries between 2000 and 2007 in spite of their increased exposure to risk through higher leverage. Moreover, the lower the level of the risk-free interest rate, the more risk is under-estimated.

Suggested Citation

  • Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    • Handle: RePEc:ijc:ijcjou:y:2015:q:1:a:3
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    References listed on IDEAS

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    Cited by:

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    3. Andrew Filardo & Paul Hubert & Phurichai Rungcharoenkitkul, 2019. "The reaction function channel of monetary policy and the financial cycle," Documents de Travail de l'OFCE 2019-16, Observatoire Francais des Conjonctures Economiques (OFCE).
    4. Simona E. Cociuba & Malik Shukayev & Alexander Ueberfeldt, 2019. "Managing Risk Taking With Interest Rate Policy And Macroprudential Regulations," Economic Inquiry, Western Economic Association International, vol. 57(2), pages 1056-1081, April.
    5. Cociuba, Simona E. & Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Collateralized borrowing and risk taking at low interest rates," European Economic Review, Elsevier, vol. 85(C), pages 62-83.
    6. Filardo, Andrew & Hubert, Paul & Rungcharoenkitkul, Phurichai, 2022. "Monetary policy reaction function and the financial cycle," Journal of Banking & Finance, Elsevier, vol. 142(C).
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    11. Douglas da Rosa München & Herbert Kimura, 2020. "Regulatory Banking Leverage: what do you know?," Working Papers Series 540, Central Bank of Brazil, Research Department.
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    More about this item

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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