Finally, we analyze a risk-diversification model, where bond holdings hedge real exchange rate risks, while equities hedge non-financial income fluctuations. An equity home bias emerges as a calibratable equilibrium outcome

The concentration of risk within the financial system leads to systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions when the government optimally intervenes during crises. By issuing...