Staff Reports
Intermediary Leverage Cycles and Financial Stability
2014   August 2012  Number 567
Revised August 2013
JEL classification: E02, E32, G00, G28

Authors: Tobias Adrian and  Nina Boyarchenko

We present a theory of financial intermediary leverage cycles within a dynamic model of the macroeconomy. Intermediaries face risk-based funding constraints that give rise to procyclical leverage and a procyclical share of intermediated credit. The pricing of risk varies as a function of intermediary leverage, and asset return exposure to intermediary leverage shocks earns a positive risk premium. Relative to an economy with constant leverage, financial intermediaries generate higher consumption growth and lower consumption volatility in normal times, at the cost of endogenous systemic financial risk. The severity of systemic crisis depends on intermediaries' leverage and net worth. Regulations that tighten funding constraints affect the systemic riskreturn trade-off by lowering the likelihood of systemic crises at the cost of higher pricing of risk.


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