EconPapers    
Economics at your fingertips  
 

Equilibrium Risk Shifting and Interest Rate in an Opaque Financial System

Edouard Challe, Benoit Mojon and Xavier Ragot

Working papers from Banque de France

Abstract: We analyze the risk-taking behavior of heterogenous intermediaries that are protected by limited liability and choose both their amount of leverage and the risk exposure of their portfolio. Due to the opacity of the financial sector, outside providers of funds cannot distinguish prudent intermediaries from imprudent ones that voluntarily hold high-risk portfolios and expose themselves to the risk of bankrupcy. We show how the number of imprudent intermediaries is determined in equilibrium jointly with the interest rate, and how both ultimately depend on the cross-sectional distribution of intermediaries capital. One implication of our analysis is that an exogenous increase in the supply of funds to the intermediary sector (following, e.g., capital inflows) lowers interest rates and raises the number of imprudent intermediaries (the risk-taking channel of low interest rates). Another one is that easy financing may lead an increasing number of intermediaries to gamble for resurrection following a bad shock to the sector s capital, again raising economy wide systemic risk (the gambling-for-resurrection channel of falling equity).

Keywords: Risk shifting; Portfolio correlation; Systemic risk; Financial opacity. (search for similar items in EconPapers)
JEL-codes: E44 G01 G20 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2012
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Downloads: (external link)
https://publications.banque-france.fr/sites/defaul ... g-paper_391_2012.pdf (application/pdf)

Related works:
Journal Article: Equilibrium risk shifting and interest rate in an opaque financial system (2013) Downloads
Working Paper: Equilibrium risk shifting and interest rate in an opaque financial system (2013) Downloads
Working Paper: Equilibrium risk shifting and interest rate in an opaque financial system (2013) Downloads
Working Paper: Equilibrium Risk Shifting and Interest Rate in an Opaque Financial System (2012) Downloads
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:bfr:banfra:391

Access Statistics for this paper

More papers in Working papers from Banque de France Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS. Contact information at EDIRC.
Bibliographic data for series maintained by Michael brassart ().

 
Page updated 2025-03-22
Handle: RePEc:bfr:banfra:391