The limits of market discipline: proprietary trading and aggregate risk
Market discipline is the mechanism by which the adjustment of cost of capital to the level of risk feeds into managerial incentives and deters excessive risk-taking. We show that risk-taking by entrepreneurs and demand for risky securities by risk-neutral investors (e.g. fund managers or proprietary traders) are mutually reinforcing. Larger risk-neutral fund managers (relative to risk-averse investors) not only undermine market discipline and lead to more risk-taking, but they also benefit more from the upside of risk and become relatively larger if the project pays out, which leads to even more risk-taking in the next period. The model explains documented features of the business cycle: bubble-like asset prices (procyclical run-up in prices and procyclical underpricing of risk), shorter cycles and countercyclical leverage of the non-financial sector.
|Date of creation:||2011|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Alessandro Barbarino & Boyan Jovanovic, 2007.
"Shakeouts And Market Crashes,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 48(2), pages 385-420, 05.
- Alessandro Barbarino & Boyan Jovanovic, 2004. "Shakeouts and Market Crashes," NBER Working Papers 10556, National Bureau of Economic Research, Inc.
- Zhiguo He & Arvind Krishnamurthy, 2008. "A Model of Capital and Crises," NBER Working Papers 14366, National Bureau of Economic Research, Inc. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:red:sed011:1013. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.