Asset price volatility and banks

This paper examines the operation of Diamond–Dybvig banks when depositors have access to the asset market. Previous studies have shown that banks are redundant in this environment since it is impossible to prevent the strategic withdrawals. This paper shows that the strategic withdrawals can be prevented if the market risk, due to asset price volatility, is considered. Banks provide deterministic returns to the depositors since the aggregate withdrawals are predictable, and therefore, banks can choose the portfolio such that no asset liquidation is involved. However, an individual consumer with stochastic liquidity need is vulnerable to the price volatility if he holds the asset directly. Therefore, banks improve the consumers’ welfare by providing the insurance against not only the liquidity shock but also the market risk. Banks are not redundant.     

Optimal Diamond–Dybvig mechanism in large economies with aggregate uncertainty

This paper characterizes the direct mechanism which implements the constrained optimal outcome in a version of Diamond and Dybvig (1983) with aggregate uncertainty and a continuum of agents. Using this result, numerical examples where the best direct mechanism has a bank-run-equilibrium are easily obtained.     

The shadow costs of repos and bank liability structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank׳s financing structure. In our model the bank׳s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long-term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank׳s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long-term debt financing. These shadow costs limit the bank׳s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank׳s financing choices and show that all these tools are able to curb the bank׳s reliance on repos.     

Forecasting distress in cooperative banks: The role of asset quality

This paper analyzes the drivers of financial distress that were experienced by small Italian cooperative banks during the latest deep recession, focusing mainly on the importance of bank capital as a predictor of bankruptcy for Italian nonprofit banks. The analysis aims to build an early-warning model that is suitable for this type of bank.The results reveal non-monotonic effects of bank capital on the probability of failure. In contrast to distress models for for-profit banks, non-performing loans, profitability, liquidity, and management quality have a negligible predictive value. The findings also show that unreserved impaired loans have an important impact on the probability of bank distress. Moreover, the loan–loss ratio provision on substandard loans constitutes a suitable antibody against bank distress. Overall, the results are robust in terms of both the methodology (i.e., frequentist and Bayesian approaches) and the sample used (i.e., cooperative banks in Italy and euro-area countries).     

The federal funds market,excess reserves,and unconventional monetary policy

Following the bankruptcy of Lehman Brothers, interbank borrowing and lending dropped, whereas reserve holdings of depository institutions skyrocketed, as the Fed injected liquidity into the U.S. banking sector. This paper introduces bank liquidity risk and limited market participation into a real business cycle model with ex ante identical financial intermediaries and shows, in an analytically tractable way, how interbank trade and excess reserves emerge in general equilibrium. Investigating the role of the federal funds market and unconventional monetary policy for the propagation of aggregate real and financial shocks, I find that federal funds market participation is irrelevant in response to standard supply and demand shocks, whereas it matters for “uncertainty shocks”, i.e. mean-preserving spreads in the cross-section of liquidity risk. Liquidity injections by the central bank can absorb the effects of financial shocks on the real economy, although excess reserves might increase and federal funds might be crowded out, as a side effect.     

Liquidity indicators,early warning signals in banks,and financial crises

This research compares the performance of three liquidity indicators, namely liquidity ratio (LiqR), liquidity creation (LiqC) and net stable funding difference (NSFD), for sending early warning signals for distressed banks. Recent evidence has shown that LiqR appears incapable of measuring the liquidity condition of banks. However, LiqC and NSFD have not yet been fully examined. Thus, which indicator is more useful in an early warning model becomes an interesting issue. We classify distressed banks as banks that have experienced a bank run, bailout, or failure. Sample data are collected from the United States and the European Union from before and after the financial crisis. We then estimate model predictive value using the sample before the crisis to predict liquidity shortages. Evidence shows that the academic (LiqC) and officially recommended indicators (NSFD) outperform LiqR as early warning signals. Furthermore, LiqC performs best when banks actively engage in income diversification but not fund diversification. Therefore, a well income-diversified bank with high LiqC tends to have high distress probability in the next period.     

Impact of Basel III liquidity regulations on U.S. Bank performance in different conditional profitability spectrums

We study the impact of the Basel III liquidity constraints, represented by the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR), on bank profitability, by employing the simultaneous quantile regression framework with time fixed effects. We find a positive and significant relationship between the LCR and profitability and the NSFR and profitability over most quantiles. However, the small magnitudes of the coefficients on LCR and NSFR across all quantiles of profitability suggest that LCR and NSFR have a minor quantitative impact on bank profitability. We then test and find that the Basel III liquidity constraints have a significantly different impact on banks with very low profits compared to banks who enjoy high profitability, emphasizing the need to use a quantile approach. We plot the coefficients to illustrate the impact of liquidity constraints across different conditional profitability spectrums. Lastly, we find that small banks are more vulnerable to short term liquidity risks (LCR) and big banks are more susceptible to medium to long term liquidity risks (NSFR). This suggests that considerations should be given to tailoring liquidity regulations based on the bank size and the relative bank profitability. The quantitatively small impact of the constraints suggest that Basel III has successfully set liquidity requirements to minimize the impact on bank profitability and the likelihood of an industry-wide liquidity crisis.     

Existence of an equilibrium for infinite horizon economies with and without complete information

This work proves the existence of an equilibrium for an infinite horizon economy where trade takes place sequentially over time. There exist two types of agents: the first correctly anticipates all future contingent endogenous variables with complete information as in Radner [Radner, R. (1972). Existence of equilibrium of plans, prices and price expectations in a sequence of markets. Econometrica, 289–303] and the second has exogenous expectations about the future environment as in Grandmont [Grandmont, J. M. (1977). Temporary general equilibrium theory. Econometrica, 535–572] and information based on the current and past aggregate variables including those which are private knowledge. Agents with exogenous expectations may have inconsistent optimal plans but have predictive beliefs in the context of Blackwell and Dubbins [Blackwell, D., Dubins, L. (1962). Merging of opinions with increasing information. The Annals of Mathematical Statistics, 882–886] with probability transition rules based on all observed variables. We provide examples of this framework applied to models of differential information and environments exhibiting results of market selection and convergence of an equilibrium. The existence result can be used to conclude that, by adding the continuity assumption on the probability transition rules, we obtain the existence of an equilibrium for some models of differential information and incomplete markets.     

Can central banks run out of ammunition? The role of the money‐equities‐interaction channel in monetary policy

Many authorities claim that central banks ‘have run out of ammunition’, either because the central bank rate has dropped close to the zero lower bound or because of Keynes's liquidity trap. I argue first, that indefinitely large increases in the quantity of money remain possible even with the central bank rate close to zero, and, second, that increases in the quantity of money raise all asset prices, including the prices of quoted equities, not just bond prices. Bonds are an unimportant asset class in modern capitalist economies, relative to corporate equity and real estate. Meanwhile increases in equity prices always boost aggregate demand and output.     

Inconsequential arbitrage

We introduce the concept of inconsequential arbitrage and, in the context of a model allowing short-sales and half-lines in indifference surfaces, prove that inconsequential arbitrage is sufficient for existence of equilibrium. Moreover, with a slightly stronger condition of nonsatiation than that required for existence of equilibrium and with a mild uniformity condition on arbitrage opportunities, we show that inconsequential arbitrage, the existence of a Pareto optimal allocation, and compactness of the set of utility possibilities are equivalent. Thus, when all equilibria are Pareto optimal — for example, when local nonsatiation holds — inconsequential arbitrage is necessary and sufficient for existence of an equilibrium. By further strengthening our nonsatiation condition, we obtain a second welfare theorem for exchange economies allowing short sales.Finally, we compare inconsequential arbitrage to the conditions limiting arbitrage of Hart [Hart, O.D., 1974. J. Econ. Theory 9, 293–311], Werner [Werner, J., 1987. Econometrica 55, abs1403–1418], Dana et al. [Dana, R.A., Le Van, C., Magnien, F., 1999. J. Econ. Theory 87, 169–193] and Allouch [Allouch, N., 1999. Equilibrium and no market arbitrage. CERMSEM, Universite de Paris I]. For example, we show that the condition of Hart (translated to a general equilibrium setting) and the condition of werner are equivalent. We then show that the Hart/Werner conditions imply inconsequential arbitrage. To highlight the extent to which we extend Hart and Werner, we construct an example of an exchange economy in which inconsequential arbitrage holds (and is necessary and sufficient for existence), while the Hart/Werner conditions do not hold.     

The impact of government intervention on the stabilization of domestic financial markets and on U.S. banks’ asset composition

The 2007–2009 financial crisis that evolved from various factors including the housing boom, aggressive lending activity, financial innovation, and increased access to money and capital markets prompted unprecedented U.S. government intervention in the financial sector. We examine changes in banks’ balance sheet composition associated with U.S. government intervention during the crisis. We find that the initial round of quantitative easing positively impacts bank liquidity across all bank samples. Our results show a positive impact of repurchase agreement market rates on bank liquidity for small and medium banks. We conclude that banks have become more liquid in the post-crisis period, especially the larger banks (large and money center banks). We show that real estate loan portfolio exposures have reverted to pre-crisis levels for money center banks and remained flat for all other bank samples.     

解析温州民间借贷

2011年12月5日,中国人民银行决定下调存款类金融机构人民币存款准备金率0.5个百分点至21%。这是近3年来中国人民银行首次下调存款准备金率,目的是加强金融体系流动性管理,抑制货币信贷过快增长,这已释放出一定的政策信号:央行已采取行动缓解当前货币资金偏紧状况。     

Anonymous sequential games with aggregate uncertainty

In this paper we extend a result of Jovanovic and Rosenthal (Anonymous sequential games, Journal of Mathematical Economics 17, 1988) on the existence of equilibrium in Anonymous Sequential Games. Jovanovic and Rosenthal prove existence in the case where the aggregate distribution of agents' characteristics evolves nonstochastically - the case of ‘no aggregate uncertainty’. Here we show how aggregate uncertainty can be introduced into the model (so the aggregate distribution evolves stochastically) and extend the Jovanovic-Rosenthal existence theorem to this case.     

Multiple equilibria in two-sector monetary economies: An interplay between preferences and the timing for money

In this paper, we study the occurrence of local indeterminacy in two-sector monetary economies. We consider a general MIUF model with two alternative timings in monetary payments: the Cash-In-Advance timing, in which the cash available to buy goods is money in the consumers’ hands after they leave the bond market but before they enter the goods market, and the Cash-After-the-Market timing, in which agents hold money for transactions after leaving the goods market. We consider three standard specifications of preferences: the additively separable formulation, the Greenwood–Hercovitz–Huffman (GHH) (Greenwood et al., 1988) formulation and the King–Plosser–Rebelo (KPR) (King et al., 1988) formulation. First, we show that for all the three types of preferences, local indeterminacy occurs under the CIA timing with a low enough interest rate elasticity of money demand. Second, we show that with the CAM timing, although determinacy always holds under separable preferences, local indeterminacy can occur with GHH and KPR preferences. We thus prove that compared to aggregate models, two-sector models provide new rooms for local indeterminacy when non-separable standard preferences are considered.     

Equilibrium turnpike theory with time-separable utility

The purpose of this paper is to show that under reasonably general conditions intertemporal competitive equilibrium has a turnpike property. The model is general because it permits (1) time-variant, time-separable utility functions, (2) heterogeneous rates of discount across consumers, and (3) matching flatness in utilities and production possibilities. The results rely on bounded marginal utility for all consumers and aggregate stationarity of utilities of the set of most patient consumers. Under these assumptions, the neighborhood turnpike result holds with (1) and (2) because of the eventual unimportance of the impatient consumer. Matching flatness requires the use of a two-sided Liapounov function and the growth theoretic methods of McKenzie.     

Interest rates and financial fragility

How do the interest rates banks earn on their assets affect the susceptibility of the banking system to a self-fulfilling run by depositors? I study this question in a version of the model of Diamond and Dybvig (1983) with limited commitment and a non-trivial portfolio choice. I show that the relationship between these interest rates and financial fragility is often non-monotone. For example, a small increase in the return on illiquid investment (or a small increase in the term premium) may raise banks’ susceptibility to a run, while a larger increase would make the banking system more stable. The same is true for changes in short-term rates, holding the longer-term rates fixed. I provide a precise characterization of these comparative statics of financial fragility.     

The bank lending channel of monetary transmission in Brazil: A VECM approach

This paper tests for the existence of a lending channel in the transmission of monetary policy in Brazil using aggregate monthly data for the period 1995:12 through 2008:6. The test is carried out in a VECM setting that allows for multiple cointegrating relationships among the variable of interest. We find evidence of two cointegrating vectors, which we identify as loan demand and supply functions by testing for a number of exclusion and exogeneity restrictions on the cointegrating relationships. Loan supply is found to be negatively related to the interbank deposit certificate rate, suggesting the existence of a lending channel for monetary transmission. The VECM's short-term dynamics show that loan demand is equilibrium-correcting. But short-term disequilibria in the supply of loans are corrected through changes in the interbank deposit certificate rate, suggesting that monetary policy plays a role in restoring equilibrium in the credit market by affecting the borrowing rate faced by banks to raise non-deposit funds.     

Aggregation of heterogeneous beliefs

This paper is a generalization of [Calvet, L., Grandmont, J.-M., Lemaire, I., 2002. Aggregation of heterogenous beliefs and asset pricing in complete financial markets. Working paper] to a dynamic setting. We propose a method to aggregate heterogeneous individual probability beliefs, in dynamic and complete asset markets, into a single consensus probability belief. This consensus probability belief, if commonly shared by all investors, generates the same equilibrium prices as well as the same individual marginal valuation as in the original heterogeneous probability beliefs setting. As in [Calvet, L., Grandmont, J.-M., Lemaire, I., 2002. Aggregation of heterogenous beliefs and asset pricing in complete financial markets. Working paper], the construction stands on a fictitious adjustment of the market portfolio. The adjustment process reflects the aggregation bias due to the diversity of beliefs. In this setting, the construction of a representative agent is shown to be also valid.     

Liquidity creation and bank profitability

This paper examines the effect of liquidity creation on bank profitability. Using a panel of US banks, we find that liquidity creation is associated with higher profitability. This result holds during normal times and the financial crisis, and for banks of different sizes. When we decompose liquidity creation into its individual components, we find that liability-side and off-balance sheet liquidity creation are positively related to profitability, while asset-side liquidity creation is negatively related to profitability.     

Constrained inefficiency in GEI: A geometric argument

In this paper we use global analysis to study the welfare properties of general equilibrium economies with incomplete markets (GEI). Our main result is to show that constrained Pareto optimal equilibria are contained in a submanifold of the equilibrium set. This result is explicitly derived for economies with real assets and fixed aggregate resources, of which real numéraire assets are a special case. As a by product of our analysis, we propose an original global parametrization of the equilibrium set that generalizes to incomplete markets the classical one, first, proposed by Lange [Lange, O., 1942. The foundations of welfare economics. Econometrica 10, 215–228].