A Model of Capital and Crises
University of Chicago - Booth School of Business, and NBER
Northwestern University - Kellogg School of Management
September 15, 2010
AFA 2011 Denver Meetings Paper
We develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices. The model is cast within a dynamic general equilibrium economy, and the role for intermediation is derived endogenously based on optimal contracting considerations. Low intermediary capital reduces the risk-bearing capacity of the marginal investor. We show how this force helps to explain patterns during financial crises. The model replicates the observed rise during crises in Sharpe ratios, conditional volatility, correlation in price movements of assets held by the intermediary sector, and fall in riskless interest rates.
Number of Pages in PDF File: 49
Keywords: Liquidity, Hedge Funds, Delegation, Financial Institutions
JEL Classification: G12, G2, E44working papers series
Date posted: March 15, 2009 ; Last revised: September 19, 2010
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