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Bailouts, sovereign risk and bank portfolio choices

Marco Casiraghi ()

Journal of Banking & Finance, 2020, vol. 119, issue C

Abstract: I study the role of sovereign risk in determining the effects of expected bailouts on banks’ portfolio decisions. Empirically, data on Italian banks show that they decrease lending to firms and increase purchases of government bonds following an increase in the probability of a bailout, if the risk of sovereign default is sufficiently low. Crucially, the portfolio adjustment becomes weaker and eventually reverses sign as sovereign risk increases. To interpret these results, I develop a model in which the relation between the bailout probability and the corresponding payoff to bank owners (“bailout rents”) depends on sovereign risk. The model’s predictions are consistent with the key features of the data.

Keywords: Bank Bailout; Government bonds; Bank lending; Sovereign risk; Credit rating (search for similar items in EconPapers)
JEL-codes: E44 G21 G24 G28 H12 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jbankfin.2020.105906

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