Research

Publications

Optimal Bailouts and the Doom Loop with a Financial Network (with Agostino Capponi & Joseph E. Stiglitz) [Video Presentation]

Journal of Monetary Economics, Vol. 128, pp. 35-50

Banks usually hold large amounts of domestic public debt which makes them vulnerable to their own sovereign's default risk. At the same time, governments often resort to costly public bailouts when their domestic banking sector is in trouble. We investigate how the interbank network structure and the distribution of sovereign debt holdings jointly affect the optimal bailout policy in the presence of this "doom loop". Rescuing banks with high domestic sovereign exposure is optimal if these banks are sufficiently central in the network, even though that requires larger bailout expenditures than rescuing low-exposure banks. Our findings imply that highly central banks can use exposure to their own government as a strategic tool to increase the likelihood of being bailed out. Our model thus illustrates how the "doom loop" exacerbates the "too interconnected to fail" problem in banking.

Working Papers

Borrowing Beyond Bounds: How Banks Pass On Regulatory Compliance Costs (with Melina Papoutsi)        [Presentation@ECB]

Regulators monitor concentration risk by requiring banks to report borrowers with loans exceeding 10% of the bank's capital. We examine whether this reporting requirement has unintended consequences for the lending behavior of European banks. We find that after a reform that lowered the reporting threshold, banks shift more exposures below it and charge large clients higher interest rates than those just under the threshold. This “large exposure penalty” is stronger for smaller, unrated firms in areas with weaker bank competition. Our findings suggest that banks pass the cost of supervisory reporting onto borrowers with limited alternatives.

Learning About Convenience Yield from Holdings (with Lira Mota & Melina Papoutsi)

Investors value financial assets for both cash flows and services like liquidity and regulatory benefits. These services give rise to a “convenience yield” — a yield spread between assets with similar cash flows. However, such a residual measure reveals little about the underlying drivers of convenience yields. Using comprehensive bond characteristics and portfolio holdings data on corporate and sovereign bonds in the euro area, we decompose the convenience yield of AAA-rated sovereign bonds into liquidity, duration, risk-based capital value, and collateral components. Our findings show that over the past decade, convenience yields have been primarily driven by insurance companies and pension funds’ preference for bonds with low risk-based capital requirements and high duration – characteristics that help these institutions meet regulatory obligations. Policy-induced shocks to these services significantly impact asset prices and portfolio allocations. These results highlight the importance of asset-specific service flows in bond valuation and monetary policy transmission.

Work in Progress

What Constrains Bank Lending? A Cross-Sectional Analysis of the Marginal Propensity to Lend

Prepared under the 2023 Lamfalussy Fellowship Programme sponsored by the ECB

Trade, Competition, and Innovation: Evidence from Europe and the US (with John Finlay & Federico Kochen)