Leverage-induced systemic risk under Basle II and other credit risk policies

@inproceedings{Poledna2014LeverageinducedSR,
  title={Leverage-induced systemic risk under Basle II and other credit risk policies},
  author={Sebastian Poledna and Stefan Thurner and J. Doyne Farmer and John Geanakoplos},
  year={2014}
}
We use a simple agent based model of value investors in financial markets to test three credit regulation policies. The first is the unregulated case, which only imposes limits on maximum leverage. The second is Basle II and the third is a hypothetical alternative in which banks perfectly hedge all of their leverageinduced risk with options. When compared to the unregulated case both Basle II and the perfect hedge policy reduce the risk of default when leverage is low but increase it when… CONTINUE READING