We address the paradox that financial innovations aimed at risk-sharing appear to have made the world riskier … liquid assets. When risk-sharing is primitive, agents selfhedge and hold more liquid assets; this buffers aggregate risks …, resulting in few correlated failures compared to when there is greater risk sharing. We apply this insight to build a model of a …

. Anticipation of this generates an equilibrium featuring systemic risk in which all banks choose inefficiently high leverage to fund …

risk in which all banks choose inefficiently high leverage to fund correlated assets and market discipline is compromised … ; systemic risk ; bailout ; forbearance ; moral hazard ; capital requirements …

regular core capital requirement that helps deter excessive risk-taking incentives. The second tier, a novel aspect of our … framework, is a special capital account that limits risk taking but preserves creditors' monitoring incentives. -- capital … requirements ; leverage ; systemic risk …

turn, banks hoard liquidity and decrease term lending as their rollover risk increases over the term of the loan. High …

-seeking behavior by firms. Firms with high liquidity risk are likely to use cash rather than credit lines for liquidity management … because the cost of monitored liquidity insurance increases with liquidity risk. We exploit a quasi-experiment around the … downgrade of General Motors (GM) and Ford in 2005 and find that firms that experienced an exogenous increase in liquidity risk …