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Macroprudential Policy and Financial Stability

Paper Session

Friday, Jan. 4, 2019 10:15 AM - 12:15 PM

Hilton Atlanta, 209-210-211
Hosted By: American Finance Association
  • Chair: Stacey Schreft, U.S. Office of Financial Research

Interest Rates and Insurance Company Investment Behavior

Ali Ozdagli
,
Federal Reserve Bank of Boston
Zixuan Kevin Wang
,
Harvard University

Abstract

Life insurance companies, the largest institutional holders of corporate bonds, tilt their portfolios towards higher-yield bonds when interest rates decline. This tilt seems to be primarily driven by an increase in duration rather than credit risk and insurers do not seem to increase the credit risk of their bonds as interest rates decline. Moreover, the duration gap between their assets and liabilities deviates from zero for extended periods of time both in negative and positive directions. These patterns cannot be explained by incentives to reach for yield. We propose a new model of duration-matching under adjustment costs that conforms with these patterns and test other implications of this model.

The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment

John Kandrac
,
Federal Reserve Board
Bernd Schlusche
,
Federal Reserve Board

Abstract

We exploit an exogenous reduction in bank supervision to demonstrate a causal effect of supervisory resources on financial institutions' willingness to take risk. The additional risk took the form of more risky loans, faster asset growth, and a greater reliance on low quality capital. This response to less supervision boosted banks' odds of failure. Lastly, we identify channels by which the reduction in supervisory capacity led to more costly failures relative to unaffected areas. None of these patterns are present in depository institutions subject to a different supervisor but otherwise similar to the banks in our sample.

Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability

Benjamin Bernard
,
University of California-Los Angeles
Agostino Capponi
,
Columbia University
Joseph Stiglitz
,
Columbia University

Abstract

We develop a theoretical framework to address the question of how a regulator can incentive banks to contribute to a voluntary bail-in. At the heart of the issue lies the credibility of the regulator's threat to not bail out the financial system without the bail-in contributions of banks. We show that credible bail-in strategies exist if and only if the network hazard does not exceed a certain threshold. Incentives to join a bail-in consortium are stronger in networks where banks are more exposed to contagion, such as in sparsely connected networks, than in densely connected networks where banks know that a large part of the benefits from their bail-in contributions accrue to other banks. Our results highlight the fundamental role played by the network structure in deciding whether a rescue can be financed from sources within the banking network or whether it has to be financed by taxpayer money.
Discussant(s)
Bo Becker
,
Stockholm School of Economics
Christa Bouwman
,
Texas A&M University
Alireza Tahbaz-Salehi
,
Northwestern University
JEL Classifications
  • G2 - Financial Institutions and Services