Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153779
Authors: 
Korinek, Anton
Year of Publication: 
2011
Series/Report no.: 
ECB Working Paper 1345
Abstract: 
This paper analyzes the efficiency of risk-taking decisions in an economy that is prone to systemic risk, captured by financial amplification effects that occur in response to strong adverse shocks. It shows that decentralized agents who have unconstrained access to a complete set of Arrow securities choose to expose themselves to such risk to a socially inefficient extent because of pecuniary externalities that are triggered during financial amplification. The paper develops an externality pricing kernel that quantifies the state-contingent magnitude of such externalities and provides welfaretheoretic foundations for macro-prudential policy measures to correct the distortion. Furthermore, it derives conditions under which agents employ ex-ante risk markets to fully undo any expected government bailout. Finally, it finds that constrained market participants face socially insufficient incentives to raise more capital during episodes of financial amplification.
Subjects: 
bailout neutrality
externality pricing kernel
financial amplification
macroprudential regulation
systemic externalities
systemic risk
JEL: 
E44
G13
G18
D62
H23
Document Type: 
Working Paper

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