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Financial Risk Capacity

Saki Bigio

No 97, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: Financial crises appear to persist if banks fail to be recapitalized quickly after large losses. I explain this impediment through a model where banks provide intermediation services in asset markets with informational asymmetries. Intermediation is risky because banks take positions over assets under disadvantageous information. Large losses reduce bank net worth and, therefore, the capacity to bear further losses. Losing this capacity leads to reductions in intermediation volumes that exacerbate adverse selection. Adverse selection, in turn, lowers bank prots which explains the failure to attract new equity. These financial crises are characterized by a depression in economic growth that is overcome only as banks slowly strengthen by retaining earnings. The model is calibrated and used to analyze several policy interventions.

New Economics Papers: this item is included in nep-ban, nep-cba and nep-dge
Date: 2012
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Working Paper: Financial Risk Capacity (2014) Downloads
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