Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy
Banque de France
European Central Bank (ECB)
Paris School of Economics (PSE); Banque de France
October 1, 2009
Banque de France Working Paper No. 254
We set up a model where asset price bubbles due to risk shifting can be moderated by capital requirements. However, imperfect information about the ratio of required capital, or, in the context of the sub-prime crisis, the extent of regulatory arbitrage, introduces uncertainty about the risk exposure of intermediaries. Underestimation of regulatory arbitrage may induce households to infer that higher asset prices are due to a decline of risk. First, this mechanism can explain why the risk premia paid by US financial intermediaries did not increase between 2000 and 2007 in spite of its increasing leverage.
Number of Pages in PDF File: 40
Keywords: Capital requirements, Imperfect Information, Risk-taking Channel of monetary policy
JEL Classification: E5, G12, G18, G32working papers series
Date posted: June 27, 2010
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