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Equilibrium Risk Shifting and Interest Rate in an Opaque Financial System

Author

Listed:
  • Edouard Challe

    (Department of Economics, Ecole Polytechnique - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique, Banque de France, CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique)

  • Benoit Monjon

    (Centre de recherche de la Banque de France - Banque de France)

  • Xavier Ragot

    (Centre de recherche de la Banque de France - Banque de France, PSE - Paris School of Economics)

Abstract

We analyse the risk-taking behaviour of heterogenous intermediaries that are protected by limited liability and choose both their amount of leverage and the risk exposure of their portfolio. Due the opacity of the financial sector, outside providers of funds cannot distinguishing "prudent" intermediaries from those "imprudent" ones that voluntarily hold high-risk portfolios and expose themselves to the risk of bankrupcy. We show how the number of imprudent intermediaries is determined in equilibrium jointly with the interest rate, and how both ultimately depend on the cross-sectional distribution of intermediaries'capital. One implication of our analysis is that an exogenous increase in the supply of funds to the intermediary sector (following, e.g., capital inflows) lowers interest rates and raises the number of imprudent intermediaries (the risk-taking channel of low interest rates). Another one is that easy financing may lead an increasing number of intermediaries to gamble for resurection following a bad shock to the sector's capital, again raising economywide systemic risk (the gambling-for-resurection channel of falling equity).

Suggested Citation

  • Edouard Challe & Benoit Monjon & Xavier Ragot, 2012. "Equilibrium Risk Shifting and Interest Rate in an Opaque Financial System," Working Papers hal-00719952, HAL.
  • Handle: RePEc:hal:wpaper:hal-00719952
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-00719952v2
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    References listed on IDEAS

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    Cited by:

    1. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    2. Matheron, J. & Antipa, P., 2014. "Interactions between monetary and macroprudential policies," Financial Stability Review, Banque de France, issue 18, pages 225-240, April.
    3. Barthélemy, J. & Marx, M., 2012. "Generalizing the Taylor Principle: New Comment," Working papers 403, Banque de France.
    4. E. Mengus, 2014. "International Bailouts: Why Did Banks' Collective Bet Lead Europe to Rescue Greece?," Working papers 502, Banque de France.
    5. repec:eee:ememar:v:31:y:2017:i:c:p:116-140 is not listed on IDEAS
    6. Cociuba, Simona E. & Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Collateralized borrowing and risk taking at low interest rates," European Economic Review, Elsevier, vol. 85(C), pages 62-83.
    7. Chen, Minghua & Wu, Ji & Jeon, Bang Nam & Wang, Rui, 2017. "Monetary policy and bank risk-taking: Evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 31(C), pages 116-140.
    8. repec:eee:dyncon:v:86:y:2018:i:c:p:165-184 is not listed on IDEAS

    More about this item

    Keywords

    Financial opacity; Risk shifting; Portfolio correlation; Systemic risk; Financial opacity.;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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