A Leverage-Based Measure of Financial Instability

38 Pages Posted: 29 Aug 2014 Last revised: 23 Mar 2021

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Karol Borowiecki

University of Southern Denmark

Alexander Tepper

Federal Reserve Bank of New York

Date Written: August 1, 2014

Abstract

The size and the leverage of financial market investors and the elasticity of demand of unlevered investors define MinMaSS, the smallest market size that can support a given degree of leverage. The financial system’s potential for financial crises can be measured by the stability ratio, the fraction of total market size to MinMaSS. We use that financial stability metric to gauge the buildup of vulnerability in the run-up to the 1998 Long-Term Capital Management crisis and argue that policymakers could have detected the potential for the crisis.

Keywords: leverage, financial crisis, financial stability, minimum market size for stability, MinMaSS, instability ratio, Long-Term Capital Management, LTCM

JEL Classification: E58, G01, G10, G20

Suggested Citation

Adrian, Tobias and Borowiecki, Karol and Tepper, Alexander, A Leverage-Based Measure of Financial Instability (August 1, 2014). FRB of New York Staff Report No. 688, Rev. Feb. 2021, Available at SSRN: https://ssrn.com/abstract=2488155 or http://dx.doi.org/10.2139/ssrn.2488155

Tobias Adrian

International Monetary Fund ( email )

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

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

Karol Borowiecki

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

Alexander Tepper (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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