Market Procyclicality and Systemic Risk

MPRA Paper from University Library of Munich, Germany

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.

Keywords: Systemic risk; Procyclicality; Leverage; Market liquidity; Network models (search for similar items in EconPapers)
JEL-codes: G20 G28 (search for similar items in EconPapers)
Date: 2013-03, Revised 2013-03
New Economics Papers: this item is included in nep-ban and nep-rmg
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Related works:
Journal Article: Market procyclicality and systemic risk (2016)
Working Paper: Market Procyclicality and Systemic Risk
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:45156

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