Endogenous Defaults, Value-at-Risk and the Business Cycle (updated version)

Issam Samiri ()

No 562, National Institute of Economic and Social Research (NIESR) Discussion Papers from National Institute of Economic and Social Research

Abstract: I propose a general equilibrium model with endogenous defaults among producers and a Value-at-Risk rule designed to stabilise insolvency risk in the banking sector. Bank equity fluctuates with aggregate default rates, affecting banks' lending capacity. The Value-at-Risk constraint induces procyclical leverage, amplifying the impact of bank equity fluctuations on credit supply. This mechanism generates countercyclical risk premia in lending rates, thus intensifying economic shocks. Analytical exploration identifies three channels driving the dynamics of bank leverage and credit spreads: (a) the credit demand channel, (b) the bank equity channel, and (c) a risk channel that captures the interaction between default expectations and the Value-at-Risk constraint. The model is calibrated to quantitatively replicate fluctuations in banks' balance sheets, credit spreads, and real business cycle variables.

Keywords: RBC; Value-at-Risk; bank leverage; Credit Spreads; Financial Frictions (search for similar items in EconPapers)
JEL-codes: E13 E32 E44 G21 G32 (search for similar items in EconPapers)
Date: 2024-11
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-rmg
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