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Endogenous Defaults, Value-at-Risk and the Business Cycle (updated version)

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  • Issam Samiri

Abstract

I propose a general equilibrium model with endogenous defaults among producers and a Value-at-Risk rule designed to stabilise insolvency risk in the banking sector. Bank equity fluctuates with aggregate default rates, affecting banks' lending capacity. The Value-at-Risk constraint induces procyclical leverage, amplifying the impact of bank equity fluctuations on credit supply. This mechanism generates countercyclical risk premia in lending rates, thus intensifying economic shocks. Analytical exploration identifies three channels driving the dynamics of bank leverage and credit spreads: (a) the credit demand channel, (b) the bank equity channel, and (c) a risk channel that captures the interaction between default expectations and the Value-at-Risk constraint. The model is calibrated to quantitatively replicate fluctuations in banks' balance sheets, credit spreads, and real business cycle variables.

Suggested Citation

  • Issam Samiri, 2024. "Endogenous Defaults, Value-at-Risk and the Business Cycle (updated version)," National Institute of Economic and Social Research (NIESR) Discussion Papers 562, National Institute of Economic and Social Research.
    • Handle: RePEc:nsr:niesrd:562
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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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