'An analysis of the interrelationship between credit market dynamics and macroeconomic fluctuations'

This research proposal seeks to answer 4 research questions. The first question is whether fluctuations in
the price and quantity of credit are supply driven or demand driven. The view that shocks to credit supply
are an important factor driving macroeconomic fluctuations became a prevalent view following the crisis of
2007/8 and informed much of the subsequent policy response. However, the view that fluctuations in the
price and quantity of credit are primarily supply driven is contested. The second question is whether the
financial sector as a whole seeks to maximise leverage. The view that financial institutions seek to
maximise leverage subject to a Value-at-Risk constraint (i.e. subject to a maximum potential loss at a
given probability level) has become a prominent way to model credit supply shocks. However, evidence
that the financial sector as a whole behaves in this way is not clear-cut. The third question is how
incorporating uncertainty into Value-at-Risk models may affect financial sector behaviour. The distinction
between risk (where the distribution of possible outcomes is known) and uncertainty (where the
distribution is not known) may provide additional insight with which to characterise financial sector
behaviour. The fourth question is what are the implications of incorporating insurance into value-at-risk
models. This insurance may either take the form of explicit counterparty insurance (e.g. credit default
swaps) of the form of implicit state backing (e.g. 'too big to fail'). It is hoped that the answers to these
research questions will provide useful insights for macroprudential and monetary policy.