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Endogenous Defaults, Value-at-Risk and the Business Cycle

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  • Issam Samiri

Abstract

I propose a general equilibrium model with endogenous defaults and a banking sector operating under a Value-at-Risk constraint. Analytical examination reveals that (a) the Value-at-Risk rule introduces a risk premium on bank lending, (b) this risk premium fluctuates with the business cycle, amplifying the impact of real shocks, and (c) bank leverage also fluctuates with real shocks, but its cyclical behaviour depends on the shocks' effects on default expectations, credit demand, and the bank's balance sheet. Assuming TFP shocks as the sole exogenous source of fluctuation, the model quantitatively replicates realistic fluctuations in banks' leverage, equity, lending, and credit spreads.

Suggested Citation

  • Issam Samiri, 2024. "Endogenous Defaults, Value-at-Risk and the Business Cycle," National Institute of Economic and Social Research (NIESR) Discussion Papers 555, National Institute of Economic and Social Research.
    • Handle: RePEc:nsr:niesrd:555
    as

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    References listed on IDEAS

    as
    1. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    2. Joao F. Gomes & Amir Yaron & Lu Zhang, 2003. "Asset Prices and Business Cycles with Costly External Finance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 767-788, October.
    3. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    4. François Gourio, 2013. "Credit Risk and Disaster Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 1-34, July.
    5. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    6. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(3), pages 823-866.
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    8. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
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    11. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    RBC; Value-at-Risk; bank leverage; Credit Spreads; Financial Frictions;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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