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Market Procyclicality and Systemic Risk

Tasca, Paolo; Battiston, Stefano; (2013) Market Procyclicality and Systemic Risk. (MPRA Paper 45156). Munich Personal RePEc Archive: Munich, Germany. Green open access

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Abstract

We model the systemic risk associated with the so-called balance-sheet amplification mechanism in a system of banks with interlocked balance sheets and with positions in real-economy-related assets. Our modeling framework integrates a stochastic price dynamics with an active balance-sheet management aimed to maintain the Value-at-Risk at a target level. We find that a strong compliance with capital requirements, usually alleged to be procyclical, does not increase systemic risk unless the asset market is illiquid. Conversely, when the asset market is illiquid, even a weak compliance with capital requirements increases significantly systemic risk. Our findings have implications in terms of possible macro-prudential policies to mitigate systemic risk.

Type: Working / discussion paper
Title: Market Procyclicality and Systemic Risk
Open access status: An open access version is available from UCL Discovery
DOI: 10.2139/ssrn.2170293
Publisher version: http://mpra.ub.uni-muenchen.de/45156/
Language: English
Additional information: This version is the version of record. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: Systemic risk, Procyclicality, Leverage, Market liquidity, Network models
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL BEAMS
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science > Dept of Computer Science
URI: https://discovery-pp.ucl.ac.uk/id/eprint/10179674
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