Asset Portfolio Choice of Banks and Inflation Dynamics

Kosuke Aoki and Nao Sudo
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Kosuke Aoki: University of Tokyo

No 12-E-5, Bank of Japan Working Paper Series from Bank of Japan

Abstract: Since the mid-1990s, the asset portfolios of Japanese banks have continuously tilted toward government bonds, while lending to firms has declined. In this paper, we investigate the causes and consequences of such changes in banks' behavior by introducing banks' asset portfolio decision into an otherwise standard New Keynesian dynamic stochastic general equilibrium model. In our model, banks construct their portfolios under the value at risk constraint, which requires banks to repay their debt regardless of the return on their assets or whether the maximum loss on their assets materialized. As a result, the maximum loss on assets and banks' net worth affect banks' balance sheet and asset portfolio allocation by changing their risk taking capacity. For instance, an increase in downside risks or a deterioration in banks' net worth reduces their risk taking capacity, and results in a contraction of their balance sheets as well as rebalancing of their portfolios toward government bonds, thus dampening output and inflation. We estimate the model by Bayesian estimation and find that such portfolio decisions played an important role in the accumulation of government bonds and deflation in Japan since the latter half of the 1990s.

Keywords: Value at Risk Constraint; Banks' Asset Allocation; Deflation; Lost Decade (search for similar items in EconPapers)
Date: 2012-07-11
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Citations: View citations in EconPapers (14)

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