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Balance Sheet Capacity and Endogenous Risk

Author

Listed:
  • 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.

Suggested Citation

  • Jon Danielsson & Hyun Song Shin & Jean-Pierre Zigrand, 2011. "Balance Sheet Capacity and Endogenous Risk," FMG Discussion Papers dp665, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp665
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP665_2011_BalanceSheetCapacity.pdf
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    More about this item

    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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