Procyclical Leverage and Value-at-Risk [report]

Tobias Adrian, Hyun Song Shin
2013 unpublished
We examine the evidence on the procyclicality of the financial system and explore its microfoundations. Contrary to the classical corporate finance approach where assets are taken as given, the evidence points to equity, not assets, as being the predetermined variable. We explore the extent to which a standard contracting model can explain the facts. Under regularity conditions on the tail of the return density, financial intermediaries' leverage is determined by a value-at-risk constraint that
more » ... isk constraint that ensures a constant probability of a financial intermediary's failure, irrespective of the risk environment. Tranquil conditions are therefore associated with balance sheet expansions.
doi:10.3386/w18943 fatcat:idpyk3dlj5ak3i5wztztflmuhq