Salience, systemic risk and spectral risk measures as capital requirements

Branka Matyska

Journal of Economic Dynamics and Control, 2021, vol. 125, issue C

Abstract: This paper evaluates the effectiveness of macroprudential capital requirements in the form of market risk measures in alleviating systemic risk, fire sales, and welfare losses in crisis resolution. We develop a general equilibrium, heterogeneous agent model with financial institutions subject to risk-based capital requirement constraint and compare the benchmark Value at Risk to three spectral risk measures. The key idea of alternative regulation is probability weighting, by which regulators overweight outcomes that are salient to them relative to their objective probabilities. We show that prudential instruments based on solely overweighting of tail market losses are preferable for policymakers aiming to reduce the likelihood of systemic crises. Overweighting both the downside and upside risks increases household welfare, but results in the financial sector’s risk-seeking preferences and exacerbates the systemic risk. The results suggest that overweighting worst-case and best-case outcomes can prevent fire sales, while overweighting intermediate outcomes leads to welfare improvements of the financial sector after uncertainty shocks.

Keywords: Systemic risk; Probability weighting; Spectral risk measures; Capital requirements; Macroprudential regulation (search for similar items in EconPapers)
JEL-codes: E44 E7 G00 G32 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188921000208
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:125:y:2021:i:c:s0165188921000208

DOI: 10.1016/j.jedc.2021.104085

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().