The Financial Origins of Non-fundamental Risk

Sushant Acharya, Keshav Dogra and Sanjay Singh

Staff Working Papers from Bank of Canada

Abstract: We formalize the idea that the financial sector can be a source of non-fundamental risk. Households’ desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate non-fundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort.

Keywords: Business fluctuations and cycles; Inflation and prices; Monetary policy (search for similar items in EconPapers)
JEL-codes: D52 D84 E62 G12 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2022-01
New Economics Papers: this item is included in nep-cba, nep-cwa, nep-mac and nep-rmg
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Related works:
Working Paper: The Financial Origins of Non-Fundamental Risk (2023)
Working Paper: The financial origins of non-fundamental risk (2021)
Working Paper: The Financial Origins of Non-Fundamental Risk (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:22-4

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