COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1838 Monitoring Leverage John Geanakoplos and Lasse H. Pedersen November 2011 We discuss how leverage can be monitored for institutions, individuals,
and assets. While traditionally the interest rate has been regarded as the
important feature of a loan, we argue that leverage is sometimes even more important.
Monitoring leverage provides information about how risk builds up during booms as leverage
rises and how crises start when leverage on new loans sharply declines. Leverage data is
also a crucial input for crisis management and lending facilities. Leverage at the asset
level can be monitored by down payments or margin requirement or and haircuts, giving a
model-free measure that can be observed directly, in contrast to other measures of
systemic risk that require complex estimation. Asset leverage is a fundamental measure of
systemic risk and so is important in itself, but it is also the building block out of
which measures of institutional leverage and household leverage can be most accurately and
informatively constructed. |
