Financial Capital and the Macroeconomy: A Quantitative Framework
41 Pages Posted: 20 May 2011
Date Written: May 5, 2011
Abstract
Financial intermediation transforms short-term liquid assets into long-term capital assets. As a result, risk taking, in the form of long-term commitments despite unresolved short-term funding risk, is an essential element of intermediation. If such funding risk must be addressed by costly recapitalization and/or distressed asset sales due to capital market frictions, an increase in uncertainty can cause a disruption in the intermediation process by forcing risk-neutral intermediaries to behave in a risk-averse manner. Our analysis examines this behavior theoretically and empirically. We first develop a dynamic macroeconomic model in which the balance sheet/liquidity condition of financial intermediaries plays an important role in the determination of asset prices and economic activity under time-varying uncertainty. Second, we present new evidence on the importance of uncertainty facing financial intermediaries for credit terms and volume and for aggregate economic activity, thereby partially quantifying the significance of capital market frictions. We adopt a structural identification strategy in which the predictions of our theory, in the form of sign restrictions, play an important role.
Keywords: Capital market friction, financial intermediary, capital constraint, liquidity based asset pricing, credit provision, uncertainty, aggregate fluctuation
JEL Classification: E32, E44
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Mitigating the Procyclicality of Basel II
By Rafael Repullo, Jesus Saurina Salas, ...
-
Mitigating the Pro-Cyclicality of Basel II
By Rafael Repullo, Jesus Saurina Salas, ...
-
Financial Sector Pro-Cyclicality: Lessons from the Crisis
By Fabio Panetta, Paolo Angelini, ...
-
The Effects of Bank Capital on Lending: What Do We Know, and What Does It Mean?
-
The Effects of Bank Capital on Lending: What Do We Know, and What Does it Mean?
-
The Procyclical Effects of Bank Capital Regulation
By Rafael Repullo and Javier Suarez
-
The Procyclical Effects of Bank Capital Regulation
By Rafael Repullo and Javier Suarez
-
The Countercyclical Capital Buffer of Basel III: A Critical Assessment
-
Earnings and Capital Management in Alternative Loan Loss Provision Regulatory Regimes
By Jesus Saurina Salas, Daniel Perez, ...