Abstract
We provide an equilibrium multi-asset pricing model with micro- founded systemic risk and heterogeneous investors. Systemic risk arises due to excessive leverage and risk taking induced by free-riding externalities. Global risk-sensitive financial regulations are introduced with a view of tackling systemic risk, with Value-at-Risk a key component. The model suggests that risk-sensitive regulation can lower systemic risk in equilibrium, at the expense of poor risk-sharing, an increase in risk premia, higher and asymmetric asset volatility, lower liquidity, more comovement in prices, and the chance that markets may not clear.
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An earlier version was presented at the Financial Stability Seminar at the Bank of England, CERGE-EI, Lancaster University, Lehman Brothers, London School of Economics, University of Maastricht, University of Würzburg and at the European Finance Association Meetings.
We thank Michel Habib, José Scheinkman, Hyun Shin and two anonymous referees for their helpful comments. Jean-Pierre Zigrand is a lecturer in Finance at the LSE, and is the corresponding author. The authors would like to acknowledge financial support under the EPSRC Grant GR/S83975/01 at the Financial Markets Group, London School of Economics.
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Daníelsson, J., Zigrand, JP. Equilibrium asset pricing with systemic risk. Economic Theory 35, 293–319 (2008). https://doi.org/10.1007/s00199-007-0238-3
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DOI: https://doi.org/10.1007/s00199-007-0238-3