Risk, uncertainty, and leverage

Khandokar Istiak and Apostolos Serletis

Economic Modelling, 2020, vol. 91, issue C, 257-273

Abstract: Using mostly theoretical models and traditional risk/uncertainty measures (VIX index, panic, precaution, scary bad news, etc.), the current literature tries to clarify the risk/uncertainty-deleveraging pattern. The findings are not sufficient to explain the dynamic empirical relationship between modern risk/uncertainty indicators and leverage. We fill this gap in the literature by using US quarterly data, from 1985:1 to 2018:4, Granger causality tests, and a structural vector autoregression model. We find that commercial bank leverage rises when geopolitical risk and macroeconomic, policy, and equity uncertainty increase. Client-based business relationships of banks and high government borrowing from banks during crises periods are responsible for this relationship. We find that the leverage of broker-dealers and shadow banks declines when Chicago risk and macroeconomic, policy, financial, and equity uncertainty increase. We argue that the vulnerability of broker-dealers and shadow banks to the risk/uncertainty of the entire market system is responsible for this relationship.

Keywords: Leverage; Risk; Uncertainty; Causality; Structural VAR (search for similar items in EconPapers)
JEL-codes: E44 E52 G23 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:91:y:2020:i:c:p:257-273

DOI: 10.1016/j.econmod.2020.06.010

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