Market Discipline and Systemic Risk

37 Pages Posted: 14 Feb 2018

See all articles by Alan D. Morrison

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Ansgar Walther

Imperial College London; Centre for Economic Policy Research (CEPR)

Date Written: February 2018

Abstract

We analyze a general equilibrium model in which financial institutions generate endogenous systemic risk, even in the absence of any government support. Banks optimally select correlated investments and thereby expose themselves to fire sale risk so as to sharpen their incentives. Systemic risk is therefore a natural consequence of banks' fundamental role as delegated monitors. Our model sheds light on recent and historical trends in measured systemic risk. Technological innovations and government-directed lending can cause surges in systemic risk. Strict capital requirements and well-designed government asset purchase programs can combat systemic risk.

Keywords: macro-prudential regulation, market discipline, return correlation, systemic risk

JEL Classification: G01, G21

Suggested Citation

Morrison, Alan and Walther, Ansgar, Market Discipline and Systemic Risk (February 2018). CEPR Discussion Paper No. DP12689, Available at SSRN: https://ssrn.com/abstract=3122331

Alan Morrison (Contact Author)

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

Ansgar Walther

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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