Balance sheet capacity and endogenous risk
Danielsson, J.
, Song Shin, H. & Zigrand, J.
(2011).
Balance sheet capacity and endogenous risk.
(Financial Markets Group Discussion Papers 665).
Financial Markets Group, The London School of Economics and Political Science.
, Song Shin, H. & Zigrand, J.
(2011).
Balance sheet capacity and endogenous risk.
(Financial Markets Group Discussion Papers 665).
Financial Markets Group, The London School of Economics and Political Science.
Banks operating under Value-at-Risk constraints give rise to a welldefined 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.