Working Paper: CEPR ID: DP10661
Authors: Blint Horvath; Harry Huizinga; Vasso Ioannidou
Abstract: We document that large European banks hold sovereign debt portfolios heavily biased toward domestic government debt. This bias is stronger if the sovereign is risky and shareholder rights are strong, as evidence of a risk-shifting explanation of the home bias. In addition, the bias is stronger if the sovereign is risky and the government has positive ownership in the bank, as evidence of a government pressure channel. The home bias is positively valued by the stock market, as reflected by a positive association between the home bias and Tobin?s q. The home bias premium declines with domestic sovereign risk, but less so for highly leveraged banks, suggesting that both the risk-shifting and government pressure channels are operative. The European Central Bank?s large injections of liquidity in December 2011 and February 2012 reduced the marginal value of the home bias by allowing banks to expand their exposure to domestic government debt.
Keywords: bank valuation; government ownership; home bias; LTRO; moral suasion; risk shifting; shareholder rights; sovereign debt crisis
JEL Codes: F3; G01; G14; G15; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased domestic sovereign risk (F34) | Greater home bias (F29) |
| Home bias (F14) | Enhanced equity returns (G12) |
| Increased domestic sovereign risk (F34) | Decline in home bias premium (F29) |
| Government ownership in banks (G21) | Increased domestic debt holdings (H63) |
| European Central Bank's liquidity injections (E52) | Expanded domestic government debt exposure (H63) |