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What happens when you regulate risk?: evidence from a simple equilibrium model

Listed author(s):
  • Zigrand, Jean-Pierre
  • Danielsson, Jon

The implications of Value-at-Risk regulations are analyzed in a CARA-normal general equilibrium model. Financial institutions are heterogeneous in risk preferences, wealth and the degree of supervision. Regulatory risk constraints lower the probability of one form of a systemic crisis, at the expense of more volatile asset prices, less liquidity, and the amplification of downward price movements. This can be viewed as a consequence of the endogenously changing risk appetite of financial institutions induced by the regulatory constraints. Finally, the Value-at-Risk constraints may prevent market clearing altogether. The role of unregulated institutions (hedge-funds) is considered. The findings are illustrated with an application to the 1987 and 1998 crises.

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File URL: http://eprints.lse.ac.uk/25069/
File Function: Open access version.
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 25069.

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Length: 42 pages
Date of creation: Oct 2001
Handle: RePEc:ehl:lserod:25069
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