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Unformatted text preview: eaudry and Lahiri (2010), though the former authors prefer to interpret the
constraint as one on value at risk. 32 Journal of Economic Perspectives supply
supply schedule XS will be upward sloping, as shown in Figure 3B, if the acceptable
able leverage ratio is higher when the spread between the expected return on
the assets in which intermediaries can invest and the rate they must pay on their
liabilities is greater. Consider, for example, a value-at-risk constraint, that requires
the future value of the intermediary’s assets to be worth at least some fraction k
of the amount owed on its debt, with at least some probability 1 – p; and suppose
that the risky asset in which the intermediary invests will pay at least a fraction s of
its expected payoff with probability 1 – p. Then the value-at-risk constraint is satisfied if and only if the intermediary’s leverage ratio (debt as a fraction of the total
value of its assets) is no greater than s/k times the factor (1 + i b)/(1 + i s)...
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