Balance-Sheet Shocks and Recapitalizations

26 Pages Posted: 25 Mar 2012

See all articles by Fabián Valencia

Fabián Valencia

International Monetary Fund (IMF)

Damiano Sandri

International Monetary Fund (IMF) - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: March 2012


We develop a dynamic stochastic general equilibrium model with financial frictions on both financial intermediaries and goods-producing firms. In this context, due to high leverage of financial intermediaries, balance sheet disruptions in the financial sector are particularly detrimental for aggregate output. We show that the welfare gains from recapitalizing the financial sector in response to large but rare net worth losses are as large as those from eliminating business cycle fluctuations. We also find that these gains are increasing in the size of the net worth loss, are larger when recapitalization funds are raised from the household rather than the real sector, and may increase with a reduction in financial intermediaries idiosyncratic risk.

Keywords: Financial Accelerator, Bank Bailouts, Leverage, Balance-sheet Shocks

JEL Classification: C61, E21, G13

Suggested Citation

Valencia, Fabian V. and Sandri, Damiano, Balance-Sheet Shocks and Recapitalizations (March 2012). IMF Working Paper No. NO.12/68. Available at SSRN:

Fabian V. Valencia (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Damiano Sandri

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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