Capital regulation induced reaching for systematic yield: Financial instability through fire sales

Martijn Boermans and Bram van der Kroft

Working Papers from DNB

Abstract: We investigate whether the omission of systematic risk in rating-based capital regulation induces strategic bond portfolio allocations that decrease financial stability. Capital regulation does not constrain systematic risk-taking by using credit ratings. We verify that this incentivizes banks and insurance corporations to hoard bonds with excessive systematic risk using a confidential bond-level holdings dataset of the ECB. Our findings highlight three interconnected channels through which this systematic risk-taking reduces financial stability by increasing the likelihood and severity of fire sales. Therefore, omitting systematic risk in capital regulation increases the fragility of the financial sector, especially in economic downturns.

Keywords: Credit ratings; systematic risk; regulatory arbitrage; portfolio concentration; capital buffers (search for similar items in EconPapers)
JEL-codes: G11 G21 G22 G24 G28 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-ban and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.dnb.nl/media/kldoxodr/working-paper-no-673.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:673

Access Statistics for this paper

More papers in Working Papers from DNB Contact information at EDIRC.
Bibliographic data for series maintained by DNB ().