Financial Capital And The Macroeconomy: A Quantitative Framework
Source: Federal Reserve Board
Financial intermediation transforms short-term liquid assets into long-term capital assets. As a result, risk taking, in the form of long-term commitments despite unresolved short-term funding risk, is an essential element of intermediation. If such funding risk must be addressed by costly recapitalization and/or distressed asset sales due to capital market frictions, an increase in uncertainty can cause a disruption in the inter-mediation process by forcing risk-neutral intermediaries to behave in a risk-averse manner. The authors' analysis examines this behavior theoretically and empirically.