Risk Pooling, Leverage, and the Business Cycle

73 Pages Posted: 25 Mar 2020 Last revised: 8 Sep 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: February 25, 2020

Abstract

This paper studies the impact of financial sector size and leverage on business cycles and risk-free rates dynamics. We model a general equilibrium productive economy where financial intermediaries provide costly risk mitigation to households by pooling the idiosyncratic risks of their investment activities. We find that leverage amplifies variations of intermediaries’ relative size, but may also mitigate the business cycle. Moreover, it makes risk-free rates pro-cyclical. Households benefit the most when the financial sector is neither too small, thus avoiding high consumption fluctuations and costly 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 (February 25, 2020). SAFE Working Paper No. 271, Available at SSRN: https://ssrn.com/abstract=3560852 or http://dx.doi.org/10.2139/ssrn.3560852

Pietro Dindo

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

Cannaregio 873
Venice, 30121
Italy

Andrea Modena

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 (Contact Author)

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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