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Procyclical Leverage and Endogenous Risk
Jon Danielsson, Hyun Song Shin and Jean-Pierre Zigrand
We explore the extent to which financial conditions fluctuate due to fluctuations in leverage, and thereby connect the recent literature on banking crises with the leverage effect of Fisher Black. We solve for equilibrium leverage and volatility inclosed form in a model with financial intermediation and explore the consequences for risk premia, asymmetric volatility and option pricing.