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Balance sheet capacity and endogenous risk

  • Jon Danielsson
  • Hyun Song Shin
  • Jean-Pierre Zigrand

Banks operating under Value-at-Risk constraints give rise to a welldefined aggregate balance sheet capacity for the banking sector as a whole that depends on total bank capital. Equilibrium risk and market risk premiums can be solved in closed form as functions of aggregate bank capital. We explore the empirical properties of the model in light of recent experience in the financial crisis and highlight the importance of balance sheet capacity as the driver of the financial cycle and market risk premiums.

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File URL: http://eprints.lse.ac.uk/43141/
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 43141.

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Length: 36 pages
Date of creation: Jan 2011
Date of revision:
Handle: RePEc:ehl:lserod:43141
Contact details of provider: Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
Phone: +44 (020) 7405 7686
Web page: http://www.lse.ac.uk/

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  1. Prasanna Gai & Nicholas Vause, 2006. "Measuring Investors' Risk Appetite," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.
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  7. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Ebens, Heiko, 2001. "The distribution of realized stock return volatility," Journal of Financial Economics, Elsevier, vol. 61(1), pages 43-76, July.
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  9. Hyun Song Shin & Emanuel Moench & Tobias Adrian, 2010. "Financial Intermediation, Asset Prices, and Macroeconomic Dynamics," 2010 Meeting Papers 297, Society for Economic Dynamics.
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  11. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  12. Antonio E. Bernardo & Ivo Welch, 2004. "Liquidity and Financial Market Runs," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 135-158, February.
  13. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-43.
  14. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  15. repec:fth:starer:98-25 is not listed on IDEAS
  16. Mele, Antonio, 2007. "Asymmetric stock market volatility and the cyclical behavior of expected returns," Journal of Financial Economics, Elsevier, vol. 86(2), pages 446-478, November.
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