Government debt and banking fragility: the spreading of strategic uncertainty
Kalin Nikolov () and
No 2195, Working Paper Series from European Central Bank
This paper studies the interaction of government debt and financial markets. This interaction, termed a ‘diabolic loop’, is driven by government choice to bail out banks and the resulting incentives for banks to hold government debt rather than self-insure through equity buffers. We highlight the role of bank equity issuance in determining whether the ‘diabolic loop’ is a Nash Equilibrium of the interaction between banks and the government. When equity is issued, no diabolic loop exists. In equilibrium, banks’ rational expectations of a bailout ensure that no equity is issued and the sovereign-bank loop is operative. JEL Classification: G01, G28, E44
Keywords: sovereign-banking loop; sovereign default (search for similar items in EconPapers)
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Journal Article: GOVERNMENT DEBT AND BANKING FRAGILITY: THE SPREADING OF STRATEGIC UNCERTAINTY (2018)
Working Paper: Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20182195
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