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The financial origins of non-fundamental risk

Author

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  • Sushant Acharya
  • Keshav Dogra
  • Sanjay R. Singh

    (Department of Economics, University of California Davis)

Abstract

We formalize the idea that the financial sector can be a source of non-fundamental risk. Households’ desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate non-fundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort.

Suggested Citation

  • Sushant Acharya & Keshav Dogra & Sanjay R. Singh, 2021. "The financial origins of non-fundamental risk," Working Papers 345, University of California, Davis, Department of Economics.
    • Handle: RePEc:cda:wpaper:345
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    Cited by:

    1. Madalen Castells Jauregui & Dmitry Kuvshinov & Björn Richter & Victoria Vanasco, 2024. "Sectoral Dynamics of Safe Assets in Advanced Economies," Working Papers 1438, Barcelona School of Economics.
    2. Madalen Castells Jauregui & Dmitry Kuvshinov & Bjoern Richter & Victoria Vanasco, 2024. "Sectoral dynamics of safe assets in advanced economies," Economics Working Papers 1884, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Joseph G. Haubrich, 2023. "Financial Stability: Frontier Risks, a New Normal, and Policy Challenges," Economic Commentary, Federal Reserve Bank of Cleveland, vol. 2023(14), pages 1-5, August.

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    More about this item

    Keywords

    safe assets; self-fulfilling asset market crashes; liquidity; fire sales;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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