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Market Discipline and Systemic Risk

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  • Morrison, Alan
  • Walther, Ansgar

Abstract

We analyze a general equilibrium model in which financial institutions generate endogenous systemic risk, even in the absence of any government support. Banks optimally select correlated investments and thereby expose themselves to fire sale risk so as to sharpen their incentives. Systemic risk is therefore a natural consequence of banks' fundamental role as delegated monitors. Our model sheds light on recent and historical trends in measured systemic risk. Technological innovations and government-directed lending can cause surges in systemic risk. Strict capital requirements and well-designed government asset purchase programs can combat systemic risk.

Suggested Citation

  • Morrison, Alan & Walther, Ansgar, 2018. "Market Discipline and Systemic Risk," CEPR Discussion Papers 12689, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12689
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    References listed on IDEAS

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    More about this item

    Keywords

    Systemic risk; Market discipline; Return correlation; Macro-prudential regulation;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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    This paper has been announced in the following NEP Reports:

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