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A Macroeconomic Model of Endogenous Systemic Risk Taking
D. Martinez-Miera and J. Suarez
DiscussionRafal Raciborski
DG ECFIN, European Commission
Norges Bank, Oslo, 29 - 30 November 2012
Disclaimer
The views expressed are the author’s alone and do not necessarily correspond to those of the
European Commission.
Context
• It's been almost 5 years that the world has been in the financial and economic crisis…
• …with its causes still not yet fully understood…• …but with a contribution of the financial sector
generally unquestioned
Most economists would agree the financial sector (banks in particular) may contribute to and
perhaps generate systemic risk
This paper
• Discusses one particular channel via which systemic risk may originate in the banking sector– Idea most closely linked to the 'risk-shifting
literature’• Embeds it into a general equilibrium model– May be disputed whether the systemic risk is truly
endogenous; more on it later• Solves nonlinearly to discuss optimal bank
capital requirements
The model: general idea• General result (Jensen&Meckling, 1976;
Stiglitz&Weiss, 1981; Allen&Gale, 2000):– Limited liability non-convexities in the profit
maximizer's problem– The maximizer may then prefer a riskier project,
pushing its risk on other agents (=risk shifting)• Banks protected by deposit insurance (limited
liability) they like riskier projects• But: riskier behavioursystemic risk– Assume that riskier projects are systematically linked
The model: available projects
• 2 types of projects:1. Less risky projects (in terms of its variance and its
mean): idiosyncratic risk2. More risky projects: risk perfectly correlated
• Higher variance of the risky projects to induce risk-shifting in the banks
• Correlation of risky projects=systemic risk• Lower unconditional mean of the risky project
probably makes things harder; conveys the idea of systemic risk being "bad"
The model: equilibrating forceDue to limited liability banks like riskier projects; why don't we observe only the riskier ones being
chosen (share of risky projects x=1)?• Crucial variable: stochastic marginal value of
one unit of a banker's wealth• Upon the realization of the systemic risk:– Wealth of 'risky banks' is wiped out– Scarce driven up for save banks: last bank standing
effect (in the spirit of Perotti&Suarez, 2002)• In equilibrium banks indifferent between
projects x
Welfare• Banks’ agency problem affects negatively the
economy via 2 channels:– Static losses: picking inefficient projects– Dynamic losses: loss of bank equity (and, hence,
lending capacity) in the event of a systemic shock• Measurement:– All agents risk neutral; but GDP does not reflect
welfare well– GDP (=added value) excludes capital losses– Does output (y=GDP+undepreciated K) correlate
perfectly with welfare in your model?
Capital requirements
• Increased capital requirements γ make capital scarcer ( higher) higher incentive to choose safer projects higher proportion of bank equity invested in safer projects
• But, banks’ lending capacity reduced lower average efficiency
• Trade-off optimal γ
Results
• For the benchmark calibration:– With low γ=7% fraction of capital invested in
systemic projects very large (70%) – Systemic shocks very painful (31% drop of GDP)– Optimal γ large (14%)– Optimal γ welfare higher by about 1%
• Number of extensions– Interesting perverse results
Minor remarks (I)
• You assume a pooling equilibrium– Are there other types of equilibria?– If so, how do we know yours is the relevant one?
• One of your main contributions: quantitative results (“high optimal γ”); but your model ‘very stylized’. For example:– Crucial role of the slope of – It would be less steep if labour were variable…
Minor remarks (II)
• An issue with calibration?– You assume 35% depreciation in failed firms– For γ=7%, 70% of all projects are systemic– This gives 35%×70%=25% capital depreciation in
the economy in the event of a systemic shock– Also the fall in GDP (30%) very large
• Develop the sensitivity analysis– “The choices for the values of […] ψ and φ are
quite tentative.”
General equilibrium?
Is systemic risk endogenous?• Yes: share of bad projects x=f(,regulation) • No: systemically-risky projects are always
there to be picked only the severity of the crisis endogenous
I believe we cannot do w/o opening the black box – see next 2 slides
Take the black box as givenWhat are the systemic projects?
• Allen&Gale (2000): oil shock – convincing, but with a limited application (Norway!)
• Your footnote 1: housing bust:– Is it systemic? What makes it so?– Was it (before 2007) considered risky? (The notion
that “house prices never fall”)• Even so: Is it plausible? Convince the reader!• What happens in your model if you have 2
types of risky projects: identical payoffs, but projects of the 2nd type independent
Bring your channel to the data“Systemic Banking Crises facts” (Boissay et al.):
a) SBC’s are rare and deepb) SBC’s are closely linked to credit developments
Ad. a) Your model can obviously match it, but:– by imposing exogenous prob. of a systemic crisis– endogenous risk correlation in recessions,
Brunnermeier&Sannikov, 2011 (parsimony)
Ad. b) Nothing to say about it– again, endogenous link (Boissay et al., 2012)– hard to make policy advice w/o a crucial channel
Need to open up the black box
Interesting perverse effect?
• Your results sensitive to the exogenous probability of a systemic crisis– Benchmark: ε=0.03
• One view: makes your results fragile• Alternative view: innovations that make the
economy safer (ε↘) make crises deeper…
Worth exploring?