|
Archive@NYU >
Stern School of Business >
Finance Working Papers >
Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/29886
|
| Title: | The Seeds of a Crisis: A Theory of Bank Liquidity and Risk-Taking over
the Business Cycle |
| Authors: | Acharya, Viral
Naqvi, Hassan |
| Issue Date: | 1-Dec-2010 |
| Series/Report no.: | FIN-10-012 |
| Abstract: | We examine how the banking sector may ignite the formation of asset
price bubbles when there is access to abundant liquidity. Inside banks,
given lack of observability of effort, loan officers (or risk takers)
are compensated based on the volume of loans but are penalized if banks
suffer a high enough liquidity shortfall. Outside banks, when there is
heightened macroeconomic risk, investors reduce direct investment and
hold more bank deposits. This ‘flight to quality’ leaves
banks flush with liquidity, lowering the sensitivity of bankers’
payoffs to downside risks of loans and inducing excessive credit volume
and asset price bubbles. The seeds of a crisis are thus sown. We show
that the optimal monetary policy involves a “leaning against
liquidity” approach: A Central Bank should adopt a contractionary
monetary policy in times of excessive bank liquidity in order to curb
risk-taking incentives at banks, and conversely, follow an expansionary
monetary policy in times of scarce liquidity so as to boost investment. |
| URI: | http://hdl.handle.net/2451/29886 |
| Appears in Collections: | Finance Working Papers
|
All items in Faculty Digital Archive are protected by copyright, with all rights reserved.
|
