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The Sovereign-Bank Diabolic Loop and ESBies

Listed author(s):
  • Markus K. Brunnermeier
  • Luis Garicano
  • Philip Lane
  • Marco Pagano
  • Ricardo Reis
  • Tano Santos
  • David Thesmar
  • Stijn Van Nieuwerburgh
  • Dimitri Vayanos

We propose a simple model of the sovereign-bank diabolic loop, and establish four results. First, the diabolic loop can be avoided by restricting banks domestic sovereign exposures relative to their equity. Second, equity requirements can be lowered if banks only hold senior domestic sovereign debt. Third, such requirements shrink even further if banks only hold the senior tranche of an internationally diversified sovereign portfolio known as ESBies in the euro-area context. Finally, ESBies generate more safe assets than domestic debt tranching alone; and, insofar as the diabolic loop is defused, the junior tranche generated by the securitization is itself risk-free.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 21993.

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Date of creation: Feb 2016
Publication status: published as Markus K. Brunnermeier & Luis Garicano & Philip R. Lane & Marco Pagano & Ricardo Reis & Tano Santos & David Thesmar & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2016. "The Sovereign-Bank Diabolic Loop and ESBies," American Economic Review, American Economic Association, vol. 106(5), pages 508-12, May.
Handle: RePEc:nbr:nberwo:21993
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  1. Farhi, Emmanuel & Tirole, Jean, 2015. "Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops," CEPR Discussion Papers 11024, C.E.P.R. Discussion Papers.
  2. Russell Cooper & Kalin Nikolov, 2013. "Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty," NBER Working Papers 19278, National Bureau of Economic Research, Inc.
  3. Jakob von Weizsäcker & Jacques Delpla, 2011. "Eurobonds: The blue bond concept and its implications," Policy Contributions 509, Bruegel.
  4. Obstfeld, Maurice, 2013. "Finance at Center Stage: Some Lessons of the Euro Crisis," CEPR Discussion Papers 9415, C.E.P.R. Discussion Papers.
  5. Viral Acharya & Itamar Drechsler & Philipp Schnabl, 2014. "A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk," Journal of Finance, American Finance Association, vol. 69(6), pages 2689-2739, December.
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