Balance Sheet Capacity and Endogenous Risk

Jon Danielsson, Hyun Song Shin and Jean-Pierre Zigrand ()

FMG Discussion Papers from Financial Markets Group

Abstract: Banks operating under Value-at-Risk constraints give rise to a well-defined aggregate balance sheet capacity for the banking sector as a whole that depends on total bank capital. Equilibrium risk and market risk premiums can be solved in closed form as functions of aggregate bank capital. We explore the empirical properties of the model in light of recent experience in the financial crisis and highlight the importance of balance sheet capacity as the driver of the financial cycle and market risk premiums.

Date: 2011-01
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Working Paper: Balance sheet capacity and endogenous risk (2011)
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