Regulatory Cliff Effects and Systemic Risk

Danmarks Nationalbank Working Paper Series, No. 117

45 Pages Posted: 2 Jan 2019 Last revised: 4 Feb 2020

See all articles by Andreas Brøgger

Andreas Brøgger

Rotterdam School of Management (RSM), Erasmus University

Graeme Cokayne

Danmarks Nationalbank (The Central Bank of Denmark)

Date Written: October 2, 2018

Abstract

We identify systemic risks arising from regulatory cliff effects. Regulatory cliff effects lead to sudden discrete changes to asset properties, causing financial agents to act simultaneously in a homogeneous way, exacerbating systemic risk. We develop a model which quantifies these effects, and find that under certain circumstances, even small changes have drastic consequences. Taking the model to the data, we find that current market measures imply that the circumstances are satisfied for the Danish financial system. The model thus sheds light on the consequences of the regulation implemented since the Great Recession, given scenarios not yet empirically observable.

Keywords: Basel Accords, Reserve Requirements, Financial Crisis, Covered Bonds, Fire Sales

JEL Classification: G28, G21

Suggested Citation

Brøgger, Andreas and Cokayne, Graeme, Regulatory Cliff Effects and Systemic Risk (October 2, 2018). Danmarks Nationalbank Working Paper Series, No. 117, Available at SSRN: https://ssrn.com/abstract=3301344 or http://dx.doi.org/10.2139/ssrn.3301344

Andreas Brøgger (Contact Author)

Rotterdam School of Management (RSM), Erasmus University ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

Graeme Cokayne

Danmarks Nationalbank (The Central Bank of Denmark) ( email )

Havnegade 5
Copenhagen, 1093
Denmark

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