Leverage-induced systemic risk under Basle II and other credit risk policies
We use a simple agent based model of value investors in financial markets to test three credit regulation policies. The first is the unregulated case, which only imposes limits on maximum leverage. The second is Basle II and the third is a hypothetical alternative in which banks perfectly hedge all...
| Main Authors: | , , , |
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| Format: | Journal article |
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Elsevier
2014
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| _version_ | 1797056155960213504 |
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| author | Poledna, S Thurner, S Farmer, J Geanakoplos, J |
| author_facet | Poledna, S Thurner, S Farmer, J Geanakoplos, J |
| author_sort | Poledna, S |
| collection | OXFORD |
| description | We use a simple agent based model of value investors in financial markets to test three credit regulation policies. The first is the unregulated case, which only imposes limits on maximum leverage. The second is Basle II and the third is a hypothetical alternative in which banks perfectly hedge all of their leverage-induced risk with options. When compared to the unregulated case both Basle II and the perfect hedge policy reduce the risk of default when leverage is low but increase it when leverage is high. This is because both regulation policies increase the amount of synchronized buying and selling needed to achieve deleveraging, which can destabilize the market. None of these policies are optimal for everyone: Risk neutral investors prefer the unregulated case with low maximum leverage, banks prefer the perfect hedge policy, and fund managers prefer the unregulated case with high maximum leverage. No one prefers Basle II. |
| first_indexed | 2024-03-06T19:19:24Z |
| format | Journal article |
| id | oxford-uuid:198d3f31-73d1-4e92-8230-a636b80c4544 |
| institution | University of Oxford |
| last_indexed | 2024-03-06T19:19:24Z |
| publishDate | 2014 |
| publisher | Elsevier |
| record_format | dspace |
| spelling | oxford-uuid:198d3f31-73d1-4e92-8230-a636b80c45442022-03-26T10:49:34ZLeverage-induced systemic risk under Basle II and other credit risk policiesJournal articlehttp://purl.org/coar/resource_type/c_dcae04bcuuid:198d3f31-73d1-4e92-8230-a636b80c4544Symplectic Elements at OxfordElsevier2014Poledna, SThurner, SFarmer, JGeanakoplos, JWe use a simple agent based model of value investors in financial markets to test three credit regulation policies. The first is the unregulated case, which only imposes limits on maximum leverage. The second is Basle II and the third is a hypothetical alternative in which banks perfectly hedge all of their leverage-induced risk with options. When compared to the unregulated case both Basle II and the perfect hedge policy reduce the risk of default when leverage is low but increase it when leverage is high. This is because both regulation policies increase the amount of synchronized buying and selling needed to achieve deleveraging, which can destabilize the market. None of these policies are optimal for everyone: Risk neutral investors prefer the unregulated case with low maximum leverage, banks prefer the perfect hedge policy, and fund managers prefer the unregulated case with high maximum leverage. No one prefers Basle II. |
| spellingShingle | Poledna, S Thurner, S Farmer, J Geanakoplos, J Leverage-induced systemic risk under Basle II and other credit risk policies |
| title | Leverage-induced systemic risk under Basle II and other credit risk
policies |
| title_full | Leverage-induced systemic risk under Basle II and other credit risk
policies |
| title_fullStr | Leverage-induced systemic risk under Basle II and other credit risk
policies |
| title_full_unstemmed | Leverage-induced systemic risk under Basle II and other credit risk
policies |
| title_short | Leverage-induced systemic risk under Basle II and other credit risk
policies |
| title_sort | leverage induced systemic risk under basle ii and other credit risk policies |
| work_keys_str_mv | AT polednas leverageinducedsystemicriskunderbasleiiandothercreditriskpolicies AT thurners leverageinducedsystemicriskunderbasleiiandothercreditriskpolicies AT farmerj leverageinducedsystemicriskunderbasleiiandothercreditriskpolicies AT geanakoplosj leverageinducedsystemicriskunderbasleiiandothercreditriskpolicies |