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Risk, Leverage, and Regulation of Financial Intermediaries

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  • Wang, Tianxi

Abstract

This paper presents a model on the leverage of financial intermediaries, where debt are held by risk averse agents and equity by the risk neutral. The paper shows that in an unregulated competitive market, financial intermediaries choose to be leveraged over the social best level. This is because the leverage of one intermediary imposes a negative externality upon others by reducing their profit margins. The paper thus founds capital adequacy regulation upon the market failure and suggests that this regulation should bind not only commercial banks, but all financial intermediaries, including private equities and hedge funds.

Suggested Citation

  • Wang, Tianxi, 2009. "Risk, Leverage, and Regulation of Financial Intermediaries," Economics Discussion Papers 2958, University of Essex, Department of Economics.
    • Handle: RePEc:esx:essedp:2958
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    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G00 - Financial Economics - - General - - - General
    • G01 - Financial Economics - - General - - - Financial Crises

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