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Collateralized Borrowing and Risk Taking at Low Interest Rates?

A view advanced in the aftermath of the late-2000s fi?nancial crisis is that lower than optimal interest rates lead to excessive risk taking by fi?nancial intermediaries. We evaluate this view in a quantitative dynamic model where interest rate policy affects risk taking through two channels. First, policy influences the attractiveness of safe bond investments relative to riskier assets. Moreover, policy changes the amount of safe bonds available for collateralized borrowing in interbank markets. In this framework, collateral constraints provide a safeguard against increases in risk taking. Lower than optimal policy rates lead to tighter collateral constraints and reduce risk taking.

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File URL: http://economics.uwo.ca/epri/workingpapers_docs/wp2012/Cociuba_Shukayev_Ueberfeldt_01.pdf
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Paper provided by University of Western Ontario, Economic Policy Research Institute in its series University of Western Ontario, Economic Policy Research Institute Working Papers with number 20121.

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Date of creation: 2012
Date of revision:
Handle: RePEc:uwo:epuwoc:20121
Contact details of provider: Postal: Economic Policy Research Institute, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2
Phone: 519-661-2111 Ext.85244
Web page: http://economics.uwo.ca/research/research_papers/epri_workingpapers.html

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  1. repec:dgr:kubcen:201030s is not listed on IDEAS
  2. Eisfeldt, Andrea L. & Rampini, Adriano A., 2006. "Capital reallocation and liquidity," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 369-399, April.
  3. Giovanni Dell'Ariccia & Robert Marquez & Luc Laeven, 2010. "Monetary Policy, Leverage, and Bank Risk-Taking," IMF Working Papers 10/276, International Monetary Fund.
  4. Itai Agur & Maria Demertzis, 2010. "Monetary Policy and Excessive Bank Risk Taking," DNB Working Papers 271, Netherlands Central Bank, Research Department.
  5. Douglas W. Diamond & Raghuram G. Rajan, 2009. "Illiquidity and Interest Rate Policy," NBER Working Papers 15197, National Bureau of Economic Research, Inc.
  6. Delis, Manthos D. & Kouretas, Georgios P., 2011. "Interest rates and bank risk-taking," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 840-855, April.
  7. Arvind Krishnamurthy & Stefan Nagel & Dmitry Orlov, 2012. "Sizing Up Repo," NBER Working Papers 17768, National Bureau of Economic Research, Inc.
  8. Giovanni Dell'Ariccia, 2010. "Monetary Policy and Bank Risk-Taking," IMF Staff Position Notes 2010/09, International Monetary Fund.
  9. Peter Hördahl & Michael R King, 2008. "Developments in repo markets during the financial turmoil," BIS Quarterly Review, Bank for International Settlements, December.
  10. Harding, Don & Pagan, Adrian, 2002. "Dissecting the cycle: a methodological investigation," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 365-381, March.
  11. repec:dgr:kubcen:200931s is not listed on IDEAS
  12. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.
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