Risk-Based Regulations in Credit Markets : A Heterogeneous Financial Accelerator

Credit markets in the U.S. are dominated by institutional investors, who are subject to various regulations limiting their risk capacity. I study the macroeconomic implications of such risk-based regulations in a general-equilibrium model featuring heterogeneous firms and a bond investor subject to risk-based constraints. During economic downturns, these risk-based constraints become a heterogeneous financial accelerator: It increases the debt financing cost for risky firms, amplifying their default risk, while generating convenience yields for the safest firms. In aggregate, these constraints significantly amplify the drop in investment and output. I also study the effects of credit market intervention policies using this framework. I find that credit policies successfully mitigate the initial drop and speed up the follow-up recovery