Working Paper: CEPR ID: DP12676
Authors: Tobias Adrian; Alexander Tepper; Karol Jan Borowiecki
Abstract: The size and the leverage of financial market investors and the elasticity of demand of unlevered investors define MinMaSS, the smallest market size that can support a given degree of leverage. The financial system's potential for financial crises can be measured by the stability ratio, the fraction of total market size to MinMaSS. We use that financial stability metric to gauge the buildup of vulnerability in the run-up to the 1998 Long-Term Capital Management crisis and argue that policymakers could have detected the potential for the crisis.
Keywords: leverage; financial crisis; financial stability; minimum market size for stability; minmass; stability ratio; long-term capital management; LTCM
JEL Codes: G01; G10; G20; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market size (L25) | stability (C62) |
| leverage (G24) | stability ratio (C62) |
| stability ratio < 1 (C62) | market instability (E32) |
| leverage (G24) | upward-sloping demand curves (D11) |
| upward-sloping demand curves (D11) | unstable equilibrium prices (D50) |
| levered investors (G19) | push system away from equilibrium (D59) |
| constant leverage ratios (G32) | deleveraging cycles (E32) |
| minmass (Y20) | stability (C62) |