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Asset Portfolio Choice of Banks and Inflation Dynamics

Author

Listed:
  • Kosuke Aoki

    (University of Tokyo)

  • Nao Sudo

    (Bank of Japan)

Abstract

Since the mid-1990s, the asset portfolios of Japanese banks have continuously tilted toward government bonds, while lending to firms has declined. In this paper, we investigate the causes and consequences of such changes in banks' behavior by introducing banks' asset portfolio decision into an otherwise standard New Keynesian dynamic stochastic general equilibrium model. In our model, banks construct their portfolios under the value at risk constraint, which requires banks to repay their debt regardless of the return on their assets or whether the maximum loss on their assets materialized. As a result, the maximum loss on assets and banks' net worth affect banks' balance sheet and asset portfolio allocation by changing their risk taking capacity. For instance, an increase in downside risks or a deterioration in banks' net worth reduces their risk taking capacity, and results in a contraction of their balance sheets as well as rebalancing of their portfolios toward government bonds, thus dampening output and inflation. We estimate the model by Bayesian estimation and find that such portfolio decisions played an important role in the accumulation of government bonds and deflation in Japan since the latter half of the 1990s.

Suggested Citation

  • Kosuke Aoki & Nao Sudo, 2012. "Asset Portfolio Choice of Banks and Inflation Dynamics," Bank of Japan Working Paper Series 12-E-5, Bank of Japan.
  • Handle: RePEc:boj:bojwps:12-e-5
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    File URL: http://www.boj.or.jp/en/research/wps_rev/wps_2012/data/wp12e05.pdf
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    References listed on IDEAS

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    Cited by:

    1. Kenji Nishizaki & Toshitaka Sekine & Yoichi Ueno, 2014. "Chronic Deflation in Japan," Asian Economic Policy Review, Japan Center for Economic Research, vol. 9(1), pages 20-39, January.
      • Kenji Nishizaki & Toshitaka Sekine & Yuichi Ueno & Yuko Kawai, 2013. "Chronic deflation in Japan," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation and inflation dynamics in Asia and the Pacific, volume 70, pages 9-19 Bank for International Settlements.
    2. Grzegorz Długoszek, 2018. "Macroeconomic Effects of Financial Uncertainty," 2018 Meeting Papers 1128, Society for Economic Dynamics.
    3. Arito Ono, Kosuke Aoki & hinichi Nishioka & Kohei Shintani & Yosuke Yasui, 2018. "Long-term interest rates and bank loan supply: Evidence from firm-bank loan-level data," Working Papers e119, Tokyo Center for Economic Research.

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