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Financial Risk Capacity

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  • Saki Bigio

    (New York University)

Abstract

Financial crises appear to persist if banks fail to be recapitalized quickly after large losses. I explain this impediment through a model where banks provide intermediation services in asset markets with informational asymmetries. Intermediation is risky because banks take positions over assets under disadvantageous information. Large losses reduce bank net worth and, therefore, the capacity to bear further losses. Losing this capacity leads to reductions in intermediation volumes that exacerbate adverse selection. Adverse selection, in turn, lowers bank prots which explains the failure to attract new equity. These financial crises are characterized by a depression in economic growth that is overcome only as banks slowly strengthen by retaining earnings. The model is calibrated and used to analyze several policy interventions.

Suggested Citation

  • Saki Bigio, 2012. "Financial Risk Capacity," 2012 Meeting Papers 97, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:97
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    References listed on IDEAS

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    1. Adrian, Tobias & Boyarchenko, Nina, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York, revised 01 Feb 2015.
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    Cited by:

    1. Javier Bianchi, 2016. "Efficient Bailouts?," American Economic Review, American Economic Association, vol. 106(12), pages 3607-3659, December.
    2. Justiniano, Alejandro & Primiceri, Giorgio E. & Tambalotti, Andrea, 2014. "Credit Supply and the Housing Boom," Working Paper Series WP-2014-21, Federal Reserve Bank of Chicago, revised 01 Mar 2014.
    3. Lawrence Christiano & Daisuke Ikeda, 2014. "Leverage Restrictions in a Business Cycle Model," Central Banking, Analysis, and Economic Policies Book Series,in: SofĂ­a Bauducco & Lawrence Christiano & Claudio Raddatz (ed.), Macroeconomic and Financial Stability: challenges for Monetary Policy, edition 1, volume 19, chapter 7, pages 215-216 Central Bank of Chile.
    4. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    5. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2013. "Risk Shocks," NBER Working Papers 18682, National Bureau of Economic Research, Inc.
    6. Zhiguo He & Arvind Krishnamurthy, 2014. "A Macroeconomic Framework for Quantifying Systemic Risk," NBER Working Papers 19885, National Bureau of Economic Research, Inc.
    7. Joseph Mullins & Gaston Navarro & Julio Blanco, 2013. "Equilibrium Default and Slow Recoveries," 2013 Meeting Papers 694, Society for Economic Dynamics.

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