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Balance sheet capacity and endogenous risk

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

Abstract

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.

Suggested Citation

  • Danielsson, Jon & Song Shin, Hyun & Zigrand, Jean-Pierre, 2011. "Balance sheet capacity and endogenous risk," LSE Research Online Documents on Economics 43141, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:43141
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Adrian, Tobias & Boyarchenko, Nina, 2013. "Intermediary balance sheets," Staff Reports 651, Federal Reserve Bank of New York.
    2. Ing-Haw Cheng & Andrei Kirilenko & Wei Xiong, 2015. "Convective Risk Flows in Commodity Futures Markets," Review of Finance, European Finance Association, vol. 19(5), pages 1733-1781.
    3. Raffestin, Louis, 2014. "Diversification and systemic risk," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 85-106.
    4. Adrian, Tobias & Boyarchenko, Nina, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York, revised 01 Feb 2015.
    5. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity - Theory and Empirical Evidence," FMG Discussion Papers dp709, Financial Markets Group.
    6. Adrian, Tobias & Boyarchenko, Nina & Shin, Hyun Song, 2015. "On the scale of financial intermediaries," Staff Reports 743, Federal Reserve Bank of New York, revised 01 Dec 2016.
    7. Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
    8. Dimitri Vayanos & Peter Kondor, 2014. "Liquidity Risk and the Dynamics of Arbitrage Capital," 2014 Meeting Papers 912, Society for Economic Dynamics.
    9. Sushanta K Mallick & Madhusudan Mohanty & Fabrizio Zampolli, 2017. "Market volatility, monetary policy and the term premium," BIS Working Papers 606, Bank for International Settlements.
    10. Billio, Monica & Getmansky, Mila & Lo, Andrew W. & Pelizzon, Loriana, 2012. "Econometric measures of connectedness and systemic risk in the finance and insurance sectors," Journal of Financial Economics, Elsevier, vol. 104(3), pages 535-559.
    11. Kris Boudt & Jon Danielsson & Siem Jan Koopman & Andre Lucas, 2012. "Regime switches in the volatility and correlation of financial institutions," Working Paper Research 227, National Bank of Belgium.
    12. Dewachter, Hans & Wouters, Raf, 2014. "Endogenous risk in a DSGE model with capital-constrained financial intermediaries," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 241-268.
    13. Maghyereh, Aktham I. & Awartani, Basel & Bouri, Elie, 2016. "The directional volatility connectedness between crude oil and equity markets: New evidence from implied volatility indexes," Energy Economics, Elsevier, vol. 57(C), pages 78-93.
    14. repec:bla:sajeco:v:85:y:2017:i:1:p:3-27 is not listed on IDEAS
    15. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, Elsevier.
    16. Haakon Kavli & Nicola Viegi, 2017. "Are Determinants of Portfolio Flows Always the Same? - South African Results from a Time Varying Parameter Var Model," South African Journal of Economics, Economic Society of South Africa, vol. 85(1), pages 3-27, March.
    17. Ing-Haw Cheng & Wei Xiong, 2013. "The Financialization of Commodity Markets," NBER Working Papers 19642, National Bureau of Economic Research, Inc.
    18. James D. Hamilton & Jing Cynthia Wu, 2015. "Effects Of Index‐Fund Investing On Commodity Futures Prices," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56, pages 187-205, February.
    19. Bruce Mizrach, 2012. "Comment on "Endogenous and Systemic Risk"," NBER Chapters,in: Quantifying Systemic Risk, pages 94-105 National Bureau of Economic Research, Inc.
    20. Peter Van Tassel, 2017. "Global Variance Term Premia and Intermediary Risk Appetite," 2017 Meeting Papers 149, Society for Economic Dynamics.
    21. Van Tassel, Peter & Vogt, Erik, 2016. "Global variance term premia and intermediary risk appetite," Staff Reports 789, Federal Reserve Bank of New York.
    22. Pietro Cova & Filippo Natoli, 2017. "International financial flows and the risk-taking channel," Temi di discussione (Economic working papers) 1152, Bank of Italy, Economic Research and International Relations Area.
    23. Charles D. Brummitt & Rajiv Sethi & Duncan J. Watts, 2014. "Inside Money, Procyclical Leverage, and Banking Catastrophes," Papers 1403.1637, arXiv.org.

    More about this item

    Keywords

    banking crisis; financial intermediation; value-at-risk;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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