American Economic Review Vol. 106 No. 5 2016

The Sovereign-Bank Diabolic Loop and ESBies

Markus K. Brunnermeier¹; Luis Garicano²; Philip R. Lane²; Marco Pagano²; Ricardo Reis³; Tano Santos²; David Thesmar^2,4; Stijn Van Nieuwerburgh; Dimitri Vayanos²

¹ Princeton University, Princeton, NJ 08540 (e-mail: ) · ² ? · ³ Universidade Federal do Rio Grande do Sul · ⁴ Groupement de Recherche et d'Etudes en Gestion à HEC

Abstract

We propose a simple model of the sovereign-bank diabolic loop, and establish four results. First, the diabolic loop can be avoided by restricting banks' domestic sovereign exposures relative to their equity. Second, equity requirements can be lowered if banks only hold senior domestic sovereign debt. Third, such requirements shrink even further if banks only hold the senior tranche of an internationally diversified sovereign portfolio--known as ESBies in the euro-area context. Finally, ESBies generate more safe assets than domestic debt tranching alone; and, insofar as the diabolic loop is defused, the junior tranche generated by the securitization is itself risk-free.

DOI

10.1257/aer.p20161107

Volume

106

Issue

5

Pages

508-512

Language

en

Sources

crossref bibtex:phds-export.bib openalex

Cite

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