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Financial intermediary leverage and value at risk

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  • Tobias Adrian
  • Hyun Song Shin

Abstract

We study a contracting model for the determination of leverage and balance sheet size for financial intermediaries that fund their activities through collateralized borrowing. The model gives rise to two features: First, leverage is procyclical in the sense that leverage is high when the balance sheet is large. Second, leverage and balance sheet size are both determined by the riskiness of assets. For U.S. investment banks, we find empirical support for both features of our model, that is, leverage is procyclical, and both leverage and balance sheet size are determined by measured risks. In a system context, increased risk reduces the debt capacity of the financial system as a whole, giving rise to amplified de-leveraging by institutions by way of the chain of repo transactions in the financial system.

Suggested Citation

  • Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:338
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    References listed on IDEAS

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    Keywords

    Financial leverage; Financial risk management; Assets (Accounting); Repurchase agreements; Bank liquidity;
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