Risk Pooling, Leverage, and the Business Cycle

73 Pages Posted: 24 Jul 2019 Last revised: 6 Apr 2020

See all articles by Pietro Dindo

Pietro Dindo

Ca Foscari University of Venice - Dipartimento di Economia

Andrea Modena

University of Bonn

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Leibniz Institute for Financial Research SAFE; Ca Foscari University of Venice

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Date Written: March 30, 2020

Abstract

This paper studies the impact of financial sector size and leverage on the business cycle and risk-free rates dynamics. We develop a general equilibrium model of a productive economy where financial intermediaries provide costly risk mitigation to households by pooling the idiosyncratic risks of their investment activities. In contrast to previous studies, we show that intermediaries not only amplify the variations of relative wealth between sectors, but may also mitigate business cycle fluctuations, while providing households with a risk-free asset whose real return is pro-cyclical and possibly negative. Households benefit the most when the financial sector is neither too small, thus avoiding high consumption fluctuations and costly risk mitigation, nor too big, so that fewer resources are lost after intermediation costs.

Keywords: Business Cycle, Frictions, Leverage, Mitigation, Risk Pooling

JEL Classification: E13, E32, E69, G12

Suggested Citation

Dindo, Pietro and Modena, Andrea and Pelizzon, Loriana, Risk Pooling, Leverage, and the Business Cycle (March 30, 2020). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 21, Available at SSRN: https://ssrn.com/abstract=3424531 or http://dx.doi.org/10.2139/ssrn.3424531

Pietro Dindo

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

Andrea Modena (Contact Author)

University of Bonn ( email )

Adenauerallee 24
Bonn, Hessen 53113
Germany
+(49) 228739209 (Phone)
30121 (Fax)

HOME PAGE: http://https://sites.google.com/view/andrea-modena/home?authuser=0

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

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