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Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses

  • Anton Korinek

This paper develops a simple macroeconomic model of systemic risk in the form of financial accelerator effects: adverse developments in financial markets and in the real economy mutually reinforce each other and lead to a feedback cycle of falling asset prices, deteriorating balance sheets and tightening financing conditions. We show that decentralized agents choose to expose themselves to financial accelerator effects to a socially inefficient extent and do not take on sufficient insurance against systemic risk even if given access to a complete ex-ante insurance market. We use the framework to shed light on a number of current policy issues: First, we develop a new analytical framework of macro-prudential capital adequacy requirements that take into account systemic risk by employing an externality pricing kernel. Second, we show that agents employ ex-ante risk markets to fully undo any expected government bailout. Finally, we find that constrained market participants face socially insufficient incentives to raise more capital during systemic crises.

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File URL: http://indstate.edu/business/NFI/leadership/papers/2011-WP-13_Korinek.pdf
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Paper provided by Indiana State University, Scott College of Business, Networks Financial Institute in its series NFI Working Papers with number 2011-WP-13.

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Length: 37 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:nfi:nfiwps:2011-wp-13
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  1. Hart, O. & Moore, J., 1991. "A Theory of Debt Based on the Inalienability of Human Capital," Working papers 592, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
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  13. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, vol. 58(2), pages 867-894, 04.
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  16. Efraim Benmelech & Nittai K. Bergman, 2010. "Bankruptcy and the Collateral Channel," NBER Working Papers 15708, National Bureau of Economic Research, Inc.
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