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loss distribution is exponential, the behavior of intermediaries conforms to the Value-at-Risk (VaR) rule, in which … exposure is adjusted to maintain a constant probability of default. In a system context, increased risk reduces the debt …
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We develop a theory of financial intermediary leverage cycles in the context of a dynamic model of the macroeconomy … procyclical, owing to risk-sensitive funding constraints. Relative to an economy with constant leverage, financial intermediaries … solvency and liquidity risks. We show that tightening intermediaries' risk constraints affects the systemic risk-return trade …
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