The Collateral Link between Volatility and Risk Sharing

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Abstract/Contents

Abstract: We show that aggregate volatility affects the extent to which agents can share idiosyncratic risks in financial markets. The channel is the valuation of private and public assets, which are both used as collateral in insurance contracts, but are differentially exposed to volatility. While aggregate volatility decreases the value of private assets—they are exposed to more variation—it increases the value of public assets— they become more valuable to smooth consumption intertemporally. Hence, a more volatile economy tends to damage risk sharing when the composition of collateral is biased toward private assets. By endogenizing the creation of private assets, we provide conditions under which more public collateral and more economic stability induce more private issuance, making risk sharing increasingly fragile to volatility shocks. Consistent with the model, we find empirical evidence in the U.S. that a more intense use of private assets increases the sensitivity of risk sharing to aggregate volatility.

Type of resource	text
Date created	September 1, 2021

DOI	https://doi.org/10.25740/mx724yy1861
Location	https://purl.stanford.edu/mx724yy1861

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License: This work is licensed under a Creative Commons Attribution 4.0 International license (CC BY).

Preferred citation: Infante, S. and Ordonez, G. (2022). The Collateral Link between Volatility and Risk Sharing. Stanford Digital Repository. Available at https://purl.stanford.edu/mx724yy1861

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