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Liquidity and leverage

  • Tobias Adrian
  • Hyun Song Shin

In a financial system in which balance sheets are continuously marked to market, asset price changes appear immediately as changes in net worth, prompting financial intermediaries to adjust the size of their balance sheets. We present evidence that marked-to-market leverage is strongly procyclical and argue that such behavior has aggregate consequences. Changes in dealer repurchase agreements (repos) -the primary margin of adjustment for the aggregate balance sheets of intermediaries - forecast changes in financial market risk as measured by the innovations in the Chicago Board Options Exchange Volatility Index (VIX). Aggregate liquidity can be seen as the rate of change of the aggregate balance sheet of the financial intermediaries.>

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 328.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:328
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  4. Acharya, Viral V & Pedersen, Lasse Heje, 2003. "Asset Pricing with Liquidity Risk," CEPR Discussion Papers 3749, C.E.P.R. Discussion Papers.
  5. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and financial cycles," BIS Working Papers 256, Bank for International Settlements.
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  8. Stein, Jeremy C, 1997. " Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-33, March.
  9. Tobias Adrian & Joshua Rosenberg, 2006. "Stock returns and volatility: pricing the short-run and long-run components of market risk," Staff Reports 254, Federal Reserve Bank of New York.
  10. Peter Carr & Liuren Wu, 2009. "Variance Risk Premiums," Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1311-1341, March.
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  18. John Kambhu, 2006. "Trading risk, market liquidity, and convergence trading in the interest rate swap spread," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 1-13.
  19. Nobuhiro Kiyotaki & John Moore, 2002. "Liquidity and Asset Pricing," ESE Discussion Papers 116, Edinburgh School of Economics, University of Edinburgh.
  20. Jeremy C. Stein & Anil K. Kashyap, 2000. "What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?," American Economic Review, American Economic Association, vol. 90(3), pages 407-428, June.
  21. Raghuram G. Rajan, 2005. "Has Financial Development Made the World Riskier?," Working Papers id:248, eSocialSciences.
  22. Danielsson, Jon & Shin, Hyun Song & Zigrand, Jean-Pierre, 2004. "The impact of risk regulation on price dynamics," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 1069-1087, May.
  23. Guillaume Plantin & Haresh Sapra & Hyun Song Shin, 2008. "Marking-to-Market: Panacea or Pandora's Box?," Journal of Accounting Research, Wiley Blackwell, vol. 46(2), pages 435-460, 05.
  24. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  26. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, 02.
  27. Tobias Adrian & Michael J. Fleming, 2005. "What financing data reveal about dealer leverage," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 11(Mar).
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