Debt Market Imperfections and Macroeconomic Implications

Project Start:06/2012
Researchers:Ester Faia, Nora Franken, Henning Hesse, Sören Karau, Jan Pieter Krahnen, Valeria Patella
Category: Macro Finance
Funded by:DFG

The project is funded by Deutsche Forschungsgemeinschaft (DFG)


The basic idea is to pursue and then combine two different strands of research, one in the field of general equilibrium modelling and the other in the field of financial intermediation and pricing in bank bond markets, to gain a better understanding of how macroeconomic outcomes are influenced by the complexities of financial systems. We believe that the particular imperfections studied in this project are essential for understanding why individual financial institutions faltered during this crisis. These imperfections are therefore an important ingredient in a new generation of macro models that explicitly address the fragility of a financial system. The project with an estimated total duration of six years (two phase of 3 years) is joint work by macroeconomists and finance researchers.

The research agenda of this ongoing project is articulated around three main pillars, each subdivided in different work packages. The first pillar is primarily macro-oriented and entails the development of suitable macro models for incorporating financial intermediation and default risk. In the first phase, we have applied a macro model with bank runs to analyze various policy questions and to test empirically the risk taking channel. In the second phase, we plan to analyze the consequences of excessive leverage on the macro-economic dynamic and on the formation of bubbles. Here we develop a macro model with both bank and household debt: in this model, we will consider behavioral elements that affect the formation of excessive leverage and we will focus in particular on loss averse agents (banks’ managers and households).

In the second pillar, which is mainly finance-oriented, we focus on the risk taking decisions by financial institutions. One of the work packages focuses on the response of bank risk taking to government intervention in markets. We have analyzed two such interventions in phase I: implicit bailout guarantee and sovereign default risk. Phase II will add management compensation as a third intervening factor. Another work package focuses on the response of bank risk taking to the (re-)emergence of asset securitization in loan markets. This work is concentrated in Phase II.

The third pillar is a capstone project, integrating the finance work stream, focusing on bank default propagation, with the analysis of monetary policy. During the first phase of the project, we have developed a simple numerical network model of banks that endogenizes network formation and asset correlation. This work-horse model will be extended in the second phase to include a range of policy rules and a set of different regulatory instruments. The aim is to analyze the interplay of monetary policy (targeting price stability) and financial regulation (targeting systemic stability) for different regulatory regimes and banking structures. We expect to derive policy conclusions from all work packages.

Related Published Papers

Author/sTitleYearProgram AreaKeywords
Iñaki Aldasoro, Domenico Delli Gatti, Ester FaiaBank Networks: Contagion, Systemic Risk and Prudential Policy
Journal of Economic Behavior and Organization
2017 Macro Finance Banking networks; Systemic risk; Contagion, Fire sales, Prudential regulation
Iñaki Aldasoro, Ester FaiaSystemic Loops and Liquidity Regulation
Journal of Financial Stability
2016 Macro Finance Bank runs, Liquidity scarcity, Interconnections, Contagion, Phase-in
Marcel Bluhm, Jan Pieter KrahnenSystemic Risk in an Interconnected Banking System with Endogenous Asset Markets
Journal of Financial Stability
2014 Macro Finance systemic risk, systemic risk charge, macroprudential supervision, Shapley value, financial network

Related Working Papers

No.Author/sTitleYearProgram AreaKeywords
198Henning Hesse, Boris Hofmann, James WeberThe Macroeconomic Effects of Asset Purchases Revisited2018 Macro Finance unconventional monetary policy, asset purchases, monetary transmission
212Henning HesseIncentive Effects from Write-down CoCo Bonds: An Empirical Analysis2018 Macro Finance CoCo bonds, contingent capital, endogenous risk, capital structure, incentives, monitoring
12Marcel Bluhm, Ester Faia, Jan Pieter KrahnenEndogenous Banks’ Networks, Cascades and Systemic Risk2013 Macro Finance network formation, tâtonnement, contagion
8Ignazio Angeloni, Ester Faia, Marco Lo DucaMonetary Policy and Risk Taking2013 Macro Finance bank runs, risk taking, monetary policy
48Marcel Bluhm, Jan Pieter KrahnenSystemic Risk in an Interconnected Banking System with Endogenous Asset Markets2014 Macro Finance systemic risk, systemic risk charge, macroprudential supervision, Shapley value, financial network
102Iñaki Aldasoro, Iván AlvesMultiplex Interbank Networks and Systemic Importance: An Application to European Data2015 Macro Finance interbank networks, systemic importance, multiplex networks

Related Policy Publications

Jan Pieter Krahnen,
Christian Wilde
Skin-in-the-Game in ABS Transactions: A Critical Review of Policy Options
White Paper No. 46