Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy

S. Dubecq, Benoit Mojon () and X. Ragot

Documents de Travail from Banque de France

Abstract: We set up a model where asset price bubbles due to risk shifting can be moderated by capital requirements. However, imperfect information about the ratio of required capital, or, in the context of the sub-prime crisis, the extent of regulatory arbitrage, introduces uncertainty about the risk exposure of intermediaries. Underestimation of regulatory arbitrage may induce households to infer that higher asset prices are due to a decline of risk. First, this mechanism can explain why the risk premia paid by US financial intermediaries did not increase between 2000 and 2007 in spite of its increasing leverage. Second, we provide a theory of the risk taking channel of monetary policy: in the model, the underestimation of risk is larger the lower the level of the risk free interest rate.

Keywords: Capital requirements; Imperfect Information; Risk-taking Channel of monetary policy. (search for similar items in EconPapers)
JEL-codes: E5 G12 G18 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-upt
Date: 2009

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Persistent link: http://EconPapers.repec.org/RePEc:bfr:banfra:254

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