Download Liquidity, Government Bonds and Sovereign Debt Crises

European repo market
The model
Empirical analysis
Liquidity, Government Bonds
and Sovereign Debt Crises
Francesco Molteni
European University Institute
6th International Research Conference
Bangko Sentral ng Pilipinas
September 20, 2016
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European repo market
The model
Empirical analysis
Motivations
Figure: 10-year government
bond yield spread
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European repo market
The model
Empirical analysis
Motivations
Figure: 10-year government
bond yield spread
Credit risk
I Fundamentally driven
I Self-fulfilling dynamics
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European repo market
The model
Empirical analysis
Motivations
Figure: 10-year government
bond yield spread
Credit risk
I Fundamentally driven
I Self-fulfilling dynamics
Liquidity
I Market liquidity
I Funding liquidity
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European repo market
The model
Empirical analysis
Main ideas
Government bonds are the prime collateral in the interbank market
Before the crisis government bonds were as liquid as money
circulating across banks
During the crisis the rise in sovereign risk reduced the funding
liquidity of peripheral government bonds
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European repo market
The model
Empirical analysis
Repurchase agreement
Figure: Bilateral repo contract
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European repo market
The model
Empirical analysis
Repurchase agreement
Figure: Bilateral repo contract
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European repo market
The model
Empirical analysis
Liquidity shock
Figure: Yields of 10-year Italian (LHS) and German (RHS) govt bonds
”Italian bonds are in a perfect storm at the moment. Real money investors are
running away and those investors using Italian bonds to finance will also be
clearing the decks now”.
FT 9th November 2011 ”LCH Clearnet SA raises margin on Italian bonds”
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European repo market
The model
Empirical analysis
Main contributions
1. Collect data on the European repo market and haircuts on
government bonds
2. Study the systemic impact of a liquidity shock in a DSGE
model
3. Assess empirically the consequence of a rise in haircuts on
sovereign bond yields
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European repo market
The model
Empirical analysis
Related literature
1. The US repo market during the liquidity crisis of 2007-09
Adrian and Shin (2009, 2010), Brunnermeier (2009), Copeland et al.
(2010), Gorton and Metrick (2012), Krishnamurthy et al. (2013)
2. Negative feedback between haircuts and the value of
collateral
Brunnermeier and Pedersen (2009), Ashcraft et al. (2010), Gârleanu and
Pedersen (2009)
3. Link between banking and sovereign weakness
Acharya et al. (2011), Gennaioli et al. (2014), Broner et al. (2014),
Coimbra (2014), Bocola (2015), Fahri and Tirole (2015)
4. Liquidity frictions in a DSGE model
Kiyotaki and Moore (2012), Del Negro et al. (2012), Jermann and
Quadrini (2012), Ajello (2011), Benigno and Nasticò (2013)
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European repo market
The model
Empirical analysis
Secured and unsecured borrowing
Figure: Repos and unsecured
borrowing (total turnover)
Figure: Shares of bilateral and
tri-party repos (in percent of
the total)
Source: European Money Market Survey (ECB)
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European repo market
The model
Empirical analysis
Collateral
Figure: Share of collateral in the european repo market (in percent)
Source: European Repo Survey (ICMA)
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European repo market
The model
Empirical analysis
Yields and haircuts on 10-year govt bonds
LCH Clearnet Ltd
Figure: Ireland
Figure: Portugal
Source: Bloomberg and LCH Clearnet Ltd
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European repo market
The model
Empirical analysis
Section 2
The model
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European repo market
The model
Empirical analysis
Model environment
Household
The representative household consists of a continuum of members
which are either workers or entrepreuners
Firms
Intermediaries in the production and labour market (nominal and
real rigidities)
Government
collects taxes
sets nominal interest rate
unconventional policy
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European repo market
The model
Empirical analysis
HH structure
Continuum of members j ∈ [0,1]
At the beginning of each period they receive an idiosyncratic shock
determining their profession:
(
Entrepreuneurs with probability γ
j=
Workers
with probability 1 − γ
At the end of the period asset and consumption sharing
Et
P∞
s−t
s=t β
h
Cs1−σ
1−σ
−
ω
1+ν
R1
χ
Hs (j)1+ν dj
i
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European repo market
The model
Empirical analysis
Portfolio
Table: Household’s balance sheet (financial assets)
Assets
Capital stock:
Others’ equity:
Long-term bonds:
qt Kt
qt NtO
L
QtL BPt
Short-term bonds:
QtS BPt
Liabilities
Equity issued:
S
Net worth:
Nt = NtO
qt NtI
L
S
qt Nt + QtL BPt + QtS BPt
Kt − N I
| {z }t
+
unmortgaged capital
Table: Return stream
asset
Nt
BtL
BtS
t+1
rtK
1
1
t+2
rtK
λ
0
t+3
rtK
λ2
0
...
...
...
...
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European repo market
The model
Empirical analysis
HH problem
Budget constraint
L
Ct (j) + ptI It (j) + qt [Nt+1 (j) − It (j) − λNt ] + QtL Bt+1
(j) − BtL
S
+QtS Bt+1
(j) − BtS = rtk Nt + Wt (j)Ht (j) + Dt + DtI − τt
Funding constraints
Nt+1 (j) ≥
(1 − θ)It (j)
| {z }
+λNt
borrowing constraint
L (j) ≥ (1 − φ )B L
Bt+1
t
| {z t}
liquidity constraint
S (j) ≥ 0
Bt+1
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European repo market
The model
Empirical analysis
The Government
Intertemporal budget constraint
L
S
B
BtL
S Bt+1 + T =
QtL Pt+1
−
λ
+
Q
t
t
P
P
t
t
t
BtS
Pt
+
BtL
Pt
Fiscal policy
Tt − T = ψT
BtL
Pt
−
BL
P
Conventional monetary policy
Rt = max πtψπ , 1
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European repo market
The model
Empirical analysis
The Government
Intertemporal budget constraint
L
S
B
BtL
S Bt+1 + T =
QtL Pt+1
−
λ
+
Q
t
t
P
P
t
t
t
BtS
Pt
+
BtL
Pt
Fiscal policy
Tt − T = ψT
BtL
Pt
−
BL
P
Conventional monetary policy
Rt = max πtψπ , 1
Unconventional policy
S
Bt+1
Kt
= ψB
QtS =
φt
φ
−1
1
Rt
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European repo market
The model
Empirical analysis
Liquidity shock
Laissez-faire economy
Figure: Impulse response function
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European repo market
The model
Empirical analysis
Liquidity shock
Unconventional policy
Figure: Impulse response function
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European repo market
The model
Empirical analysis
Liquidity shock
Zero lower bound
Figure: Impulse response function
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European repo market
The model
Empirical analysis
Section 3
Empirical analysis
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European repo market
The model
Empirical analysis
The model
Let
yt = [ht , CDSt , ydt ]0
yt = B(L)yt + t
where B(L) = B0 +
Pp
k
k=1 Bk L
and t ∼ (0, Σ )
Flat priors for the coefficient matrices and variance-covariance
matrix
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European repo market
The model
Empirical analysis
Identification of shock
I
Narrative approach and High Frequency Identification (HFI)
I
Choleski decomposition
I
Delay between the announcement and the implementation of
changes in haircuts
I
Shock to haircut unanticipated (liquidity surprises)
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European repo market
The model
Empirical analysis
Example of Repo Clear Margin Rate Circular
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European repo market
The model
Empirical analysis
Impulse response function
Figure: Impulse response function of government bond yields
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European repo market
The model
Empirical analysis
Robustness test
Impulse responses by local projections (Jorda)
Hansen (2000) test: threshold effect on CDS
State dependent model:
ydt = δL0 Xt −1 + βshock + utL
0
Xt −1 + βshock + utH
ydt = δH
if CDSt ≤ 600
if CDSt > 600
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European repo market
The model
Empirical analysis
Impulse response function
Figure: linear model
Figure: state-dependent model
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European repo market
The model
Empirical analysis
Conclusion
I
Liquidity channel of the European financial crisis through the
European repo market
I
Effectiveness of unconventional monetary policy in a liquidity
crisis
I
Lack of a liquid asset
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European repo market
The model
Empirical analysis
Thank you for your attention !
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