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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 Nieuwerburgh, Stijn and Vayanos, Dimitri (2016) The sovereign-bank diabolic loop and ESBies. CFM discussion paper series, CFM-DP2016-17. Centre For Macroeconomics, London, UK.

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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: Monograph (Discussion Paper)
Official URL: http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information: © 2016 The Authors
Subjects: H Social Sciences > HB Economic Theory
Sets: Departments > Economics
Departments > Finance
Departments > Management
Research centres and groups > Centre for Macroeconomics
Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 13 Dec 2017 08:59
Last Modified: 13 Dec 2017 15:37
URI: http://eprints.lse.ac.uk/id/eprint/86230

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