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Balance Sheet Capacity and Endogenous Risk

  • Jon Danielsson

    ()

  • Hyun Song Shin

    ()

  • Jean-Pierre Zigrand

    ()

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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