Abstract

http://ssrn.com/abstract=2133385
 
 

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Intermediary Leverage Cycles and Financial Stability


Tobias Adrian


Federal Reserve Bank of New York

Nina Boyarchenko


Federal Reserve Bank of New York

August 16, 2012

Becker Friedman Institute for Research in Economics Working Paper No. 2012-010

Abstract:     
We develop a theory of financial intermediary leverage cycles in the context of a dynamic model of the macroeconomy. The interaction between a production sector, a financial intermediation sector, and a household sector gives rise to amplification of fundamental shocks that affect real economic activity. The model features two state variables that represent the dynamics of the economy: the net worth and the leverage of financial intermediaries. The leverage of the intermediaries is procyclical owing to risk-sensitive funding constraints. Relative to an economy with constant leverage, financial intermediaries generate higher output and consumption growth and lower consumption volatility in normal times, but at the cost of systemic solvency and liquidity risks. We show that tightening intermediaries’ risk constraints affects the systemic risk-return trade-off, by lowering the likelihood of systemic crises at the cost of higher pricing of risk. Our model thus represents a conceptual framework for cyclical macroprudential policies within a dynamic stochastic general equilibrium model.

Number of Pages in PDF File: 65

Keywords: Systemic risk, macroprudential policy, DSGE, amplification, capital regulation, financial intermediation

JEL Classification: G00, G28, E32, E02

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Date posted: August 21, 2012  

Suggested Citation

Adrian, Tobias and Boyarchenko, Nina, Intermediary Leverage Cycles and Financial Stability (August 16, 2012). Becker Friedman Institute for Research in Economics Working Paper No. 2012-010. Available at SSRN: http://ssrn.com/abstract=2133385 or http://dx.doi.org/10.2139/ssrn.2133385

Contact Information

Tobias Adrian
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
HOME PAGE: http://nyfedeconomists.org/adrian/
Nina Boyarchenko (Contact Author)
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
212-720-7339 (Phone)
212-720-1582 (Fax)
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