Banks Interconnectivity and Leverage

Vincenzo Quadrini, Alessandro Barattieri and Laura Moretti ()

No 11502, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: In the period that preceded the 2008 crisis, US ï¬ nancial intermediaries have become more leveraged (measured as the ratio of assets over equity) and interconnected (measured as the share of liabilities held by other ï¬ nancial intermediaries). This upward trend in leverage and interconnectivity sharply reversed after the crisis. To understand the factors that could have caused this dynamic, we develop a model where banks make risky investments in the non-ï¬ nancial sector and sell part of their investments to other banks (diversiï¬ cation). The model predicts a positive correlation between leverage and interconnectivity which we explore empirically using balance sheet data for over 14,000 ï¬ nancial intermediaries in 32 OECD countries. We enrich the theoretical model by allowing for Bayesian learning about the likelihood of a bank crisis (aggregate risk) and show that the model can capture the dynamics of leverage and interconnectivity observed in the data.

Keywords: Interconnectivity; Leverage; Risk (search for similar items in EconPapers)
JEL-codes: E21 G11 G21 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-mac
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Banks Interconnectivity and Leverage (2017)
Working Paper: Banks Interconnectivity and Leverage (2016)
Working Paper: Banks Interconnectivity and Leverage (2016)
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