FINANCIAL STABILITY, SHADOW BANKING AND IDIOSYNCRATIC RISK.

Abstract

In this thesis, we study how shadow banking affects the financial stability of the economy. Shadow banking improves financial stability in economic booms but puts the economy at greater risk in the event of large negative shock. Endogenous risk does not fade away when exogenous risk falls. Variation of idiosyncratic risk has minimal effect on the economy. Tax regulation is effective in enhancing financial stability in recession but not effective in economic upturns as banks are less capable to absorb shock due to high borrowing cost.