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Risk Shifting with Fuzzy Capital Constraints

Listed author(s):
  • Simon Dubecq

    (European Central Bank - European Central Bank)

  • Benoît Mojon

    (Banque de france - Banque de France)

  • Xavier Ragot

    (PSE - Paris School of Economics, PSE - Paris-Jourdan Sciences Economiques - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)

We construct a model where risk shifting can be moderated by capital requirements. Imperfect information about the level of capital per unit of risk, however, introduces uncertainty about the risk exposure of intermediaries. Over-estimation of the capital held by financial intermediaries, or the extent of regulatory arbitrage, may induce households to wrongly infer from higher asset prices that the fundamentals of risky assets have improved. This mechanism can notably explain the low risk premia paid by U.S. financial intermediaries between 2000 and 2007 in spite of their increased exposure to risk through higher leverage. Moreover, the lower the level of the risk-free interest rate, the more risk is under-estimated.

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Paper provided by HAL in its series PSE - Labex "OSE-Ouvrir la Science Economique" with number halshs-01157527.

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Date of creation: Mar 2015
Publication status: Published in International Journal of Central Banking, 2015, pp.1-31
Handle: RePEc:hal:pseose:halshs-01157527
Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-01157527
Contact details of provider: Web page: https://hal.archives-ouvertes.fr/

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  1. Barlevy, Gadi, 2014. "A leverage-based model of speculative bubbles," Journal of Economic Theory, Elsevier, vol. 153(C), pages 459-505.
  2. repec:hrv:faseco:33077921 is not listed on IDEAS
  3. Challe, Edouard & Mojon, Benoit & Ragot, Xavier, 2013. "Equilibrium risk shifting and interest rate in an opaque financial system," European Economic Review, Elsevier, vol. 63(C), pages 117-133.
  4. Challe Edouard & Ragot Xavier, 2011. "Bubbles and Self-Fulfilling Crises," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-38, May.
  5. Matteo Ciccarelli & Angela Maddaloni & Jose Luis Peydro, 2015. "Trusting the Bankers: A New Look at the Credit Channel of Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 979-1002, October.
  6. Jiminez, G. & Ongena, S. & Saurina, J., 2007. "Hazardous Times for Monetary Policy : What do Twenty-three Million Bank Loans Say about the Effects of Monetary Policy on Credit Risk?," Discussion Paper 2007-75, Tilburg University, Center for Economic Research.
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