Intermediary leverage cycles and financial stability

Tobias Adrian and Nina Boyarchenko

No 567, Staff Reports from Federal Reserve Bank of New York

Abstract: We present a theory of financial intermediary leverage cycles within a dynamic model of the macroeconomy. Intermediaries face risk-based funding constraints that give rise to procyclical leverage and a procyclical share of intermediated credit. The pricing of risk varies as a function of intermediary leverage, and asset return exposures to intermediary leverage shocks earn a positive risk premium. Relative to an economy with constant leverage, financial intermediaries generate higher consumption growth and lower consumption volatility in normal times, at the cost of endogenous systemic financial risk. The severity of systemic crisis depends on two state variables: intermediaries? leverage and net worth. Regulations that tighten funding constraints affect the systemic risk-return tradeoff by lowering the likelihood of systemic crises at the cost of higher pricing of risk.

Keywords: financial stability; macro-finance; macroprudential; capital regulations; dynamic equilibrium models; asset pricing (search for similar items in EconPapers)
JEL-codes: E02 E32 G00 G28 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-ban and nep-dge
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Citations: View citations in EconPapers (177)

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Related works:
Working Paper: Intermediary Leverage Cycles and Financial Stability (2013)
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