Financially Constrained Banks, Credit Crunch, and Home Bias"

In this report, I present a research proposal for one chapter of my thesis. The main idea is that crisis lowers banks' net worth, impairs its intermediation activity, and more importantly leads to credit crunch and home bias in government bond holding. Here is the work plan. I first summarize the stylized facts in the European sovereign debt crisis episode. Then, I work out a model to capture these facts. Finally, I calibrate the model with GIIPS countries data and conduct counterfactual exercise of government policy to evaluate its effectiveness. During the European sovereign debt crisis, we can observe the following empirical regularities: (i) the banking sector suffers liquidity shortage; (ii) banks are reluctant to lend to private sectors; (iii) banks tends to hold more domestic government bonds even local government's default probability is high. I derive a dynamic model to capture all these facts and solve it with numerical method. The main intuition behind this model is that during the crisis, banks are severely financially constrained. As a result, the structure of the balance sheet will change, with sovereign bonds crowding out bank loans to private sector. Another key prediction of the model is that banks substitute the foreign government loan with domestic government loan. I calibrate the model with GIIPS countries data to retrieve the main parameters. The data are readily available from respected statistics authorities. I conduct counterfactual analysis with regard to different government intervention policies to conclude the paper. The contributions of this exercise are twofold. Firstly, the paper drives a dynamic model with financial friction the bank side. Secondly, it conducts counterfactual analysis of various government policies. At the moment, this paper is still at its preliminary stage and substantial efforts are needed to accomplish it."

PhD Director(s):
PhD Director: C├ędric Tille
Jury Member: Yi Huang

 Record created 2016-08-05, last modified 2018-01-29

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