Market Procyclicality and Systemic Risk

Working Papers from ETH Zurich, Chair of Systems Design

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; Network models (search for similar items in EconPapers)
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Related works:
Journal Article: Market procyclicality and systemic risk (2016)
Working Paper: Market Procyclicality and Systemic Risk (2013)
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