Liquidity and Leverage

Risk-taking channels and capital inflows into the US treasuries

“…This result indicates that appreciation in relative asset prices (compressing the spread) prompts higher leverage-a behavior consistent with procyclical leverage described in Adrian and Shin (2010). Thus, these results imply that the inflows into the US Treasuries indirectly contribute to expanded risk-taking by inducing appreciation in relative asset prices.…”

“…If international capital inflows affect interest rates and financial intermediaries are tied to asset returns and funding costs that are determined by financial markets, these inflows must indirectly affect financial intermediaries' decisions to undertake risk. Adrian and Shin (2010) provided evidence of an amplification mechanism between asset prices and leverage. Appreciation of asset prices raises leverage-defined as assets over equity-because the appreciation decreases required equity per dollar of asset that is measured by value-at-risk, which takes place simultaneously with the expansion of balance sheets that is motivated by an increase in net worth (surplus equity).…”

What happened to the quants in August 2007? Evidence from factors and transactions data

“…Once started, these spirals continue as lower asset prices and higher volatility raise margin levels and lower available leverage. Adrian and Shin (2008) document a pro-cyclical relationship between the leverage of U.S. investment banks and the sizes of their balance sheets and explore the aggregate effects that such a relationship can have on asset prices and the volatility risk premium. This empirical observation increases the likelihood of Brunnermeier's (2009) margin and deleveraging spiral.…”

Liquidity Crunch in the Interbank Market: Is it Credit or Liquidity Risk, or Both?

“…Acharya et al (2010) show that the release of information may cause the market for asset-backed securities to dry up. Adrian and Shin (2010) and Brunnermeier and Pedersen (2009) study the mechanisms amplifying the impact of a (small) shock to the balance sheet of financial intermediaries ("loss spirals" and "margin spirals"). This growing body of literature generally studies the market for short term bank liabilities-including repos and commercial paper-held by nonbank financial institutions, like mutual and hedge funds.…”