Risk pooling, leverage, and the business cycle

Arbeitspapier

This paper studies the impact of financial sector size and leverage on business cycles and risk-free rates dynamics. We model a general equilibrium productive economy where financial intermediaries provide costly risk mitigation to households by pooling the idiosyncratic risks of their investment activities. We find that leverage amplifies variations of intermediaries' relative size, but may also mitigate the business cycle. Moreover, it makes risk-free rates pro-cyclical. Households benefit the most when the financial sector is neither too small, thus avoiding high consumption fluctuations and costly mitigation, nor too big, so that fewer resources are lost after intermediation costs.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: SAFE Working Paper ; No. 271

Classification and Topics

• Classification: Wirtschaft ; General Aggregative Models: Neoclassical ; Business Fluctuations; Cycles ; Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: Other ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: Business Cycle ; Frictions ; Leverage ; Mitigation ; Risk Pooling

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Dindo, Pietro ; Modena, Andrea ; Pelizzon, Loriana
• Event: Veröffentlichung
• (who): Leibniz Institute for Financial Research SAFE
• (where): Frankfurt a. M.
• (when): 2020

Further information

• DOI: doi:10.2139/ssrn.3560852
• Handle: http://hdl.handle.net/10419/215431
• Last update: 10.03.2025, 11:42 AM CET