Modelling financial turmoil through endogenous risk
Endogenous risk
By incorporating endogenous risk into a standard asset-pricing model, this column shows how banks' capacity to bear risk seemingly evaporates in the face of market turmoil, pushing the financial system further into a tailspin. It suggests that risk-sensitive prudential regulation, in the spirit of Basel II, makes systemic financial crises sharper, larger, and more costly.