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Inflation Risk and Portfolio Allocation in the Banking System

  • Pablo Druck
  • Pietro Garibaldi

This paper proposes theory and evidence on the relationship between inflation and the bank's portfolio allocation. The proposed idea rationalized what Rodriguez (1992) pointed out with respect to the Central Bank of Argentina, behaving as a "borrower of first resort", where banks reallocated their investment from the private sector to government bonds. A main component of inflation costs is the misallocation of resources, this paper shows a channel through the reallocation of credits, where the credit market for the private sector trend to disappear. Theoretically, this paper studies the behavior of risk-neutral financiers in a world in which monitoring costs, and limited liability on the part of firms leads to credit rationing equilibria. In light of the well established relation between inflation and changes in relative prices, the theoretical model rationalizes the relationship between inflation and the allocation of capital in the banking system. Empirically, it looks at the dynamic behavior of the composition of bank's assets in Argentina between 1983 and 1998, which shows a robust relationship between relative price variability and bank's allocation in government denominated assets.

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Paper provided by Universidad del CEMA in its series CEMA Working Papers: Serie Documentos de Trabajo. with number 181.

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Date of creation: Dec 2000
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Handle: RePEc:cem:doctra:181
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  1. Guy Debelle & Owen Lamont, 1996. "Relative Price Variability and Inflation: Evidence from US Cities," NBER Working Papers 5627, National Bureau of Economic Research, Inc.
  2. Kiguel, Miguel A & Neumeyer, Pablo Andres, 1995. "Seigniorage and Inflation: The Case of Argentina," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 672-82, August.
  3. Bernanke, Ben & Gertler, Mark, 1990. "Financial Fragility and Economic Performance," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 87-114, February.
  4. Sebastian Edwards & Carlos A. Vegh, 1997. "Banks and Macroeconomics Disturbances under Predetermined Exchange Rates," NBER Working Papers 5977, National Bureau of Economic Research, Inc.
  5. Carlos A. Rodríguez, 1992. "Financial Reforms in Latin America: The Cases of Argentina, Chile and Uruguay," CEMA Working Papers: Serie Documentos de Trabajo. 84, Universidad del CEMA.
  6. Lach, Saul & Tsiddon, Daniel, 1992. "The Behavior of Prices and Inflation: An Empirical Analysis of Disaggregated Price Data," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 349-89, April.
  7. N. Gregory Mankiw, 1986. "The Allocation of Credit and Financial Collapse," NBER Working Papers 1786, National Bureau of Economic Research, Inc.
  8. Casella, Alessandra & Feinstein, Jonathan S, 1990. "Economic Exchange during Hyperinflation," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 1-27, February.
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