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Balance Sheet Capacity and Endogenous Risk

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  • Jon Danielsson

    ()

  • Hyun Song Shin

    ()

  • Jean-Pierre Zigrand

    ()

Abstract

Banks operating under Value-at-Risk constraints give rise to a well-defined 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://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP665_2011_BalanceSheetCapacity.pdf
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp665.

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Date of creation: Jan 2011
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Handle: RePEc:fmg:fmgdps:dp665
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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Find related papers by 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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  1. 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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  6. repec:fth:starer:98-25 is not listed on IDEAS
  7. Basak, Suleyman & Croitoru, Benjamin, 2000. "Equilibrium Mispricing in a Capital Market with Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 715-48.
  8. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Denis Gromb & Dimitri Vayanos, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," LSE Research Online Documents on Economics 448, London School of Economics and Political Science, LSE Library.
  10. Antonio Bernardo & Ivo Welch, 2006. "Liquidity and Financial Market Runs," Yale School of Management Working Papers ysm280, Yale School of Management, revised 01 Aug 2003.
  11. Jones, Christopher S., 2003. "The dynamics of stochastic volatility: evidence from underlying and options markets," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 181-224.
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Cited by:

  1. 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.
  2. Ing-Haw Cheng & Wei Xiong, 2013. "The Financialization of Commodity Markets," NBER Working Papers 19642, National Bureau of Economic Research, Inc.
  3. Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
  4. Tobias Adrian & Nina Boyarchenko, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York.
  5. Raffestin, Louis, 2014. "Diversification and systemic risk," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 85-106.
  6. 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.
  7. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity -- Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
  8. 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, 02.
  9. Bruce Mizrach, 2012. "Comment on "Endogenous and Systemic Risk"," NBER Chapters, in: Quantifying Systemic Risk, pages 94-105 National Bureau of Economic Research, Inc.
  10. Peter Kondor & Dimitri Vayanos, 2014. "Liquidity risk and the dynamics of arbitrage capital," LSE Research Online Documents on Economics 55910, London School of Economics and Political Science, LSE Library.
  11. Kavli, Haakon & Viegi, Nicola, 2015. "Are determinants of portfolio flows always the same? - South African results from a time varying parameter VAR model," MPRA Paper 66897, University Library of Munich, Germany.
  12. Adrian, Tobias & Boyarchenko, Nina, 2013. "Intermediary balance sheets," Staff Reports 651, Federal Reserve Bank of New York.
  13. Charles D. Brummitt & Rajiv Sethi & Duncan J. Watts, 2014. "Inside Money, Procyclical Leverage, and Banking Catastrophes," Papers 1403.1637, arXiv.org.
  14. Ing-Haw Cheng & Andrei Kirilenko & Wei Xiong, 2012. "Convective Risk Flows in Commodity Futures Markets," NBER Working Papers 17921, National Bureau of Economic Research, Inc.
  15. Adrian, Tobias & Boyarchenko, Nina & Shin, Hyun Song, 2015. "The cyclicality of leverage," Staff Reports 743, Federal Reserve Bank of New York.

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