Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses

Networks Financial Institute Working Paper No. 2011-WP-13

37 Pages Posted: 13 May 2011

See all articles by Anton Korinek

Anton Korinek

University of Virginia; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 1, 2011

Abstract

This paper develops a simple macroeconomic model of systemic risk in the form of financial accelerator effects: adverse developments in financial markets and in the real economy mutually reinforce each other and lead to a feedback cycle of falling asset prices, deteriorating balance sheets and tightening financing conditions. We show that decentralized agents choose to expose themselves to financial accelerator effects to a socially inefficient extent and do not take on sufficient insurance against systemic risk even if given access to a complete ex-ante insurance market. We use the framework to shed light on a number of current policy issues: First, we develop a new analytical framework of macro-prudential capital adequacy requirements that take into account systemic risk by employing an externality pricing kernel. Second, we show that agents employ ex-ante risk markets to fully undo any expected government bailout. Finally, we find that constrained market participants face socially insufficient incentives to raise more capital during systemic crises.

Keywords: financial amplification, systemic risk, systemic externalities, externality pricing kernel, macroprudential regulation, bailout neutrality

JEL Classification: E44, G13, G18, D62, H23

Suggested Citation

Korinek, Anton, Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses (May 1, 2011). Networks Financial Institute Working Paper No. 2011-WP-13, Available at SSRN: https://ssrn.com/abstract=1838600 or http://dx.doi.org/10.2139/ssrn.1838600

Anton Korinek (Contact Author)

University of Virginia

1400 University Ave
Charlottesville, VA 22903
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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