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Equilibrium risk shifting and interest rate in an opaque financial system

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  • Edouard Challe

    (X-DEP-ECO - Département d'Économie de l'École Polytechnique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris, CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - CNRS - Centre National de la Recherche Scientifique, Banque de france - Banque de France)

  • Benoît Mojon

    (Banque de france - Banque de France)

  • Xavier Ragot

    (Banque de france - Banque de France, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PSE - Paris-Jourdan Sciences Economiques - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)

Abstract

We analyse the risk-taking behaviour 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 those"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 lowers interest rates and raises the number of imprudent intermediaries. Another one is that easy financing may lead an increasing number of intermediaries to gamble for resurection following a bad shock to the sector 'scapital, again raising economywide systemic risk.

Suggested Citation

  • Edouard Challe & Benoît Mojon & Xavier Ragot, 2013. "Equilibrium risk shifting and interest rate in an opaque financial system," PSE-Ecole d'économie de Paris (Postprint) halshs-00944916, HAL.
    • Handle: RePEc:hal:pseptp:halshs-00944916
    DOI: 10.1016/j.euroecorev.2013.07.003
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00944916
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    Cited by:

    1. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    2. repec:spo:wpmain:info:hdl:2441/4901esivjh9o4b9spo98etscoh is not listed on IDEAS
    3. Matheron, J. & Antipa, P., 2014. "Interactions between monetary and macroprudential policies," Financial Stability Review, Banque de France, issue 18, pages 225-240, April.
    4. repec:spo:wpmain:info:hdl:2441/3bvs8clr5k9dqqcbq7j5ul2o65 is not listed on IDEAS
    5. Gilbert COLLETAZ & Grégory LEVIEUGE & Alexandra POPESCU, 2016. "Monetary Policy and Long-Run Risk-Taking," LEO Working Papers / DR LEO 2409, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
    6. Jean Barthélemy & Magali Marx, 2012. "Generalizing the Taylor Principle: New Comment," SciencePo Working papers Main hal-03461113, HAL.
    7. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    8. repec:hal:spmain:info:hdl:2441/4901esivjh9o4b9spo98etscoh is not listed on IDEAS
    9. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    10. Cociuba, Simona E. & Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Collateralized borrowing and risk taking at low interest rates," European Economic Review, Elsevier, vol. 85(C), pages 62-83.
    11. Nuno Coimbra & Hélène Rey, 2024. "Financial Cycles with Heterogeneous Intermediaries," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 91(2), pages 817-857.
    12. Jean Barthélemy & Magali Marx, 2012. "Generalizing the Taylor Principle: New Comment," SciencePo Working papers hal-03461113, HAL.
    13. Colletaz, Gilbert & Levieuge, Grégory & Popescu, Alexandra, 2018. "Monetary policy and long-run systemic risk-taking," Journal of Economic Dynamics and Control, Elsevier, vol. 86(C), pages 165-184.
    14. Chen, Minghua & Wu, Ji & Jeon, Bang Nam & Wang, Rui, 2017. "Monetary policy and bank risk-taking: Evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 31(C), pages 116-140.
    15. John V. Duca & Lilit Popoyan & Susan M. Wachter, 2019. "Real Estate And The Great Crisis: Lessons For Macroprudential Policy," Contemporary Economic Policy, Western Economic Association International, vol. 37(1), pages 121-137, January.
    16. E. Mengus, 2014. "International Bailouts: Why Did Banks' Collective Bet Lead Europe to Rescue Greece?," Working papers 502, Banque de France.
    17. Lilit Popoyan, 2020. "Macroprudential Policy: a Blessing or a Curse?," Review of Economics and Institutions, Università di Perugia, vol. 11(1-2).
    18. repec:hal:spmain:info:hdl:2441/1l43j7jn1m9sc9ieoh0b4bjnfk is not listed on IDEAS
    19. repec:hal:spmain:info:hdl:2441/3bvs8clr5k9dqqcbq7j5ul2o65 is not listed on IDEAS
    20. Acosta-Smith, Jonathan, 2018. "Interest rates, capital and bank risk-taking," Bank of England working papers 774, Bank of England.

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    More about this item

    Keywords

    Risk shifting; Portfolio correlation; Financial opacity;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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