Banks, Short Term Debt and Financial Crises: Theory, Policy Implications and Applications

Diamond, Douglas W.; Rajan, Raghuram G.

doi:10.3386/w7764

Cited by 37 publications

(23 citation statements)

References 13 publications

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“…Short-term borrowing has often been cited as a key contributor to financial instability and its curtailment has been called for on various occasions (cp. Diamond and Rajan, 2001). However, as the next graphs indicate, such regulation could turn out to be counterproductive.…”

Section: Credit Frictionsmentioning

confidence: 99%

Prices, debt and market structure in an agent-based model of the financial market

Fischer

Riedler

2014

Journal of Economic Dynamics and Control

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Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. Non-technical SummaryIn this paper we develop an agent-based model of the financial market. Agent-based modeling is a simulation-based technique that is gaining popularity in economics. In an agent-based model autonomously acting and interacting units (e.g. representing financial market participants) endogenously generate structures and system properties which become subject to analysis. In contrast to conventional equilibrium models, agent-based models prominently take into account mutual dependencies between agents and feedback processes.In our model boundedly rational agents trade a financial asset. Their trading strategy thereby depends on their return forecast which is formed by either considering fundamentals or technical analysis. This setup is well established in the literature and has been exceptionally successful in reproducing several stylized facts of financial asset price time series. With our model we analyze the behavior of a large number of heterogeneous agents. The heterogeneity can predominantly be attributed to differing trading strategies and the ensuing divergence in the structure of agents' balance sheets. The balance sheet aspect of the financial markets has been largely neglected in extant literature.Specifically, we endow each agent with a balance sheet comprising of a risky asset and cash on the asset side and equity capital and debt on the liabilities side. The risky asset is traded among agents at an endogenously set price. We assume that agents actively manage their respective balance sheet in two regards. Firstly, they choose a portfolio which optimizes the ratio between risky assets and cash conditional on their current return forecast, and secondly they aim at a fixed ratio between equity and debt (leverage ratio). Agents are constrained in their ability to acquire and dispose of debt by the credit supply of a risk managing financier and credit frictions, which hinder agents to make immediate changes to their debt levels.We simulate our model and show that it can reproduce several empirically observable facts and relationships. Although we initially endow all agents with identical balance sheets, the size distribution of agents quickly converges to a lognormal distribution, which is typically observed for investment banks. We furthermore observe a natural tendency for inequality to increase over time. When we impose low credit frictions on the model financial market, leverage becomes procyclical, which is also typical for investme...

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Section: Credit Frictionsmentioning

confidence: 99%

Prices, debt and market structure in an agent-based model of the financial market

Fischer

Riedler

2014

Journal of Economic Dynamics and Control

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“…On the same note, Diamond and Rajan (2000b) argue, from the perspective of bank financing, that the possibility of premature liquidation of short-term debt may act as an incentive to managers to pursue value maximizing decisions that may enhance firm performance.…”

Section: Introductionmentioning

confidence: 99%

Capital Structure, Profitability and Firm Value: Panel Evidence of Listed Firms in Kenya

2014

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“…In fact, for similar reasons, Titman and Tsyplakov (2007) find that equity holders may lack incentives to downward adjust firm leverage in bad times, although it is optimal to do so from the firm's perspective. See Diamond (1991), Diamond andRajan (2001b) and Brunnermeier and Oehmke (2011) for models where debt becomes shorter-term in bad times with higher probability of default, which would further increase its overhang.…”

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confidence: 99%

A Theory of Debt Maturity: The Long and Short of Debt Overhang

Diamond¹,

He²

2012

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Debt maturity influences debt overhang: the reduced incentive for highly-levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter-term debt's value depends less on firm value. Future overhang is more volatile for shorter-term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter-term debt typically imposes lower overhang; longer-term debt can impose less if firm value is more volatile in bad times. For future investments, reduced correlation between the value of assets-in-place and profitability of investment increases the overhang of shorter-term debt.

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Banks, Short Term Debt and Financial Crises: Theory, Policy Implications and Applications

Cited by 37 publications

References 13 publications

Prices, debt and market structure in an agent-based model of the financial market

Prices, debt and market structure in an agent-based model of the financial market

Capital Structure, Profitability and Firm Value: Panel Evidence of Listed Firms in Kenya

A Theory of Debt Maturity: The Long and Short of Debt Overhang

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