Salience, Systemic Risk and Spectral Risk Measures as Capital Requirements

Abstract: In this paper, we evaluate the effectiveness of macroprudential capital requirements in the form of Value at Risk and three alternative spectral risk measures from the systemic risk perspective. Overall, we find that prudential instruments based on salience and overweighting of tail market losses are beneficial for policymakers aimed to limit the procyclicality in the financial sector and reduce the likelihood of the systemic crises. In the steady-state, the financial sector exhibits risk-seeking attitudes when the risky asset upside is salient and risk-averse behavior when the downside is salient. In contrast, the overweighting of almost certain market losses results in a rapid leverage acceleration and risk-seeking preferences and exacerbates systemic risk. More important, focusing on both upside and downside risks fulfills the prudential objective of building a more resilient financial system. Our model illuminates how adverse liquidity and uncertainty shocks elicit policy responses, but also how they affect risk attitudes and the time and cross-sectional dimension of systemic risk.

- Marcel Proust-

“The voyage of discovery is not in seeking new landscapes, but having new eyes.”

Risk Management Policies of Central Clearing Counterparties (available soon)

research funded by the grant FIRR of Agence Nationale de la Recherche, ANR-18-CE26-0015-0