Intermediary Leverage Cycles and Financial Stability

64 Pages Posted: 15 Aug 2012

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Nina Boyarchenko

Federal Reserve Bank of New York

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2012

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.

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

JEL Classification: G00, G28, E32, E02

Suggested Citation

Adrian, Tobias and Boyarchenko, Nina, Intermediary Leverage Cycles and Financial Stability (August 1, 2012). FRB of New York Staff Report No. 567. Available at SSRN: https://ssrn.com/abstract=2129987 or http://dx.doi.org/10.2139/ssrn.2129987

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

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

HOME PAGE: http://www.tobiasadrian.com

Nina Boyarchenko

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-7339 (Phone)
212-720-1582 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
90
rank
37,305
Abstract Views
838
PlumX Metrics