Working Paper: CEPR ID: DP13855
Authors: Romain Rancière; Amine Ouazad; Jonas Heipertz
Abstract: The paper uses bank- and instrument-level data on asset holdings and liabilities to identify and estimate a general equilibrium model of trade in financial instruments. Bilateral ties are formed as each bank selects the size and the diversification of its assets and liabilities. Shocks propagate due to the response, rather than the size, of bilateral ties to such shocks. This general equilibrium propagation of shocks reveals a financial network where the strength of a tie is determined by the sensitivity of an instrument's return to other instruments' returns. General equilibrium analysis predicts the propagation of real, financial and policy shocks. The network's shape adjusts endogenously in response to shocks, to either amplify or mitigate partial equilibrium shocks. The network exhibits key theoretical properties: (i) more connected networks lead to less amplification of partial equilibrium shocks, (ii) the influence of a bank's equity is independent of the size of its holdings; (ii) more risk-averse banks are more diversified, lowering their own volatility but increasing their influence on other banks. The general equilibrium based network model is structurally estimated on disaggregated data for the universe of French banks. We used the estimated network to assess the effects of ECB quantitative easing policy on asset prices, balance-sheets, individual bank distress risk, and networks systemicness.
Keywords: endogenous networks; asset trade; asset and liability management; general equilibrium
JEL Codes: D85; G12; D4; D5; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| more connected financial networks (F65) | less amplification of partial equilibrium shocks (E19) |
| bank's equity (G21) | systemic impacts (F60) |
| risk-averse banks (G21) | diversify portfolios (G11) |
| diversify portfolios (G11) | lower own volatility (G17) |
| lower own volatility (G17) | increase influence on other banks (F65) |
| ECB quantitative easing (E52) | shifts in network dynamics (D85) |
| ECB quantitative easing (E52) | changes in systemic risk profiles (F65) |