What Happens When You Regulate Risk? Evidence from a Simple Equilibrium Model

42 Pages Posted: 13 Nov 2001

See all articles by Jon Danielsson

Jon Danielsson

London School of Economics - Systemic Risk Centre

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Date Written: August 2001

Abstract

The implications of Value-at-Risk regulations are analyzed in a CARA--normal general equilibrium model. Financial institutions are heterogeneous in risk preferences, wealth and the degree of supervision. Regulatory risk constraints lower the probability of one form of a systemic crisis, at the expense of more volatile asset prices, less liquidity, and the amplification of downward price movements. This can be viewed as a consequence of the endogenously changing risk appetite of financial institutions induced by the regulatory constraints. Finally, the Value-at-Risk constraints may prevent market clearing altogether. The role of unregulated institutions (hedge-funds) is considered. The findings are illustrated with an application to the 1987 and 1998 crises.

Keywords: General equilibrium; Value-at-risk; Risk regulation

JEL Classification: G12, G18, G20, D50

Suggested Citation

Danielsson, Jon and Zigrand, Jean-Pierre, What Happens When You Regulate Risk? Evidence from a Simple Equilibrium Model (August 2001). Available at SSRN: https://ssrn.com/abstract=289542 or http://dx.doi.org/10.2139/ssrn.289542

Jon Danielsson

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Jean-Pierre Zigrand (Contact Author)

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
447
Abstract Views
2,289
rank
64,741
PlumX Metrics