Sovereign risk, bank funding and investors' pessimism

Arbeitspapier

Data show that sovereign risk reduces liquidity, increases funding cost and risk of banks highly exposed to it. I build a model that rationalizes this fact. Banks act as delegated monitors and invest in risky projects and in risky sovereign bonds. As investors hear rumors of increased sovereign risk, they run the bank (via global games). Banks could rollover liquidity in repo market using government bonds as collateral, but as sovereign risk raises collateral values shrink. Overall banks' liquidity falls (its cost increases) and so does banks' credit. In this context noisy news (announcements with signal extraction) of consolidation policies are recessionary in the short run, as they contribute to investors and banks pessimism, and mildly expansionary in the medium run. The banks liquidity channel plays a major role in the fiscal transmission.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: CFS Working Paper Series ; No. 542

Classification and Topics

• Classification: Wirtschaft
• Subject: liquidity risk ; sovereign risk ; banks' funding costs

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Faia, Ester
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, Center for Financial Studies (CFS)
• (where): Frankfurt a. M.
• (when): 2016

Further information

• Handle: http://hdl.handle.net/10419/146923
• URN: urn:nbn:de:hebis:30:3-416815
• Last update: 10.03.2025, 11:44 AM CET