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The sovereign-bank diabolic loop and ESBies

Brunnermeier, Markus K. and Garicano, Luis and Lane, Philip R. and Pagano, Marco and Reis, Ricardo and Santos, Tano and Thesmar, David and Van Nieuwerberg, Stijn and Vayanos, Dimitri (2016) The sovereign-bank diabolic loop and ESBies. American Economic Review, 106 (5). pp. 508-512. ISSN 0002-8282

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Identification Number: 10.1257/aer.p20161107

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.

Item Type: Article
Official URL: https://www.aeaweb.org/aer/index.php
Additional Information: © 2016 American Economic Association
Subjects: H Social Sciences > HG Finance
Sets: Departments > Economics
Collections > Economists Online
Date Deposited: 24 Mar 2016 17:22
Last Modified: 14 Nov 2016 08:28
URI: http://eprints.lse.ac.uk/id/eprint/65863

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