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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://www2.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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  2. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
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  11. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
  12. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
  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.
  14. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
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  16. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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