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Preprints, Working Papers, ... Year : 2016

The Sovereign-Bank Diabolic Loop and Esbies

Markus Brunnermeier
  • Function : Author
Luis Garicano
  • Function : Author
Philip Lane
  • Function : Author
Marco Pagano
  • Function : Author
Tano Santos
  • Function : Author
Stijn van Nieuwerburgh
  • Function : Author
Dimitri Vayanos
  • Function : Author

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.
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hal-01993425 , version 1 (24-01-2019)

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  • HAL Id : hal-01993425 , version 1

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Markus Brunnermeier, Luis Garicano, Philip Lane, Marco Pagano, Ricardo Reis, et al.. The Sovereign-Bank Diabolic Loop and Esbies. 2016. ⟨hal-01993425⟩
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