Banks Interconnectivity and Leverage

Vincenzo Quadrini, Laura Moretti () and Alessandro Barattieri

No 504, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: In the period that preceded the 2008 crisis, US financial intermediaries have become more leveraged (measured as the ratio of assets over equity) and interconnected (measured as the share of liabilities held by other financial intermediaries). This upward trend in leverage and interconnectivity sharply reversed after the crisis. To understand this dynamic pattern we develop a model where banks make risky investments in the non-financial sector and sell part of their investments to other financial institutions (diversification). The model predicts a positive correlation between leverage and interconnectivity which we explore empirically using balance sheet data for over 14,000 financial 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.

Date: 2017
New Economics Papers: this item is included in nep-ban and nep-dge
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Related works:
Working Paper: Banks Interconnectivity and Leverage (2016)
Working Paper: Banks Interconnectivity and Leverage (2016)
Working Paper: Banks Interconnectivity and Leverage (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:504

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