The sovereign-bank diabolic loop and ESBies

Markus Brunnermeier, Luis Garicano, Philip Lane, Marco Pagano, Ricardo Reis, Tano Santos, David Thesmar, Stijn Van Nieuwerberg and Dimitri Vayanos

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: 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.

Keywords: diabolic loop; sovereign debt crisis; government default; bank default; bailout; ESBies (search for similar items in EconPapers)
JEL-codes: G18 G21 G28 H63 (search for similar items in EconPapers)
Date: 2016-05-01
New Economics Papers: this item is included in nep-pke
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Citations: View citations in EconPapers (16)

Published in American Economic Review, 1, May, 2016, 106(5), pp. 508-512. ISSN: 0002-8282

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http://eprints.lse.ac.uk/65863/ Open access version. (application/pdf)

Related works:
Journal Article: The Sovereign-Bank Diabolic Loop and ESBies (2016)
Working Paper: The sovereign-bank diabolic loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and Esbies (2016)
Working Paper: The sovereign-bank diabolic loop and ESBies (2016)
Working Paper: The sovereign-bank diabolic loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and Esbies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and ESBies (2016)
Working Paper: The Sovereign-Bank Diabolic Loop and ESBies (2016)
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