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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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