Search for Yield

Abstract

We present a model of the relationship between real interest rates, credit spreads, and the structure and risk of the banking system. Banks intermediate between entrepreneurs and investors, and can monitor entrepreneurs' projects. We characterize the equilibrium for a fixed aggregate supply of savings, showing that safer entrepreneurs will be funded by nonmonitoring banks and riskier entrepreneurs by monitoring banks. We show that an increase in savings reduces interest rates and spreads, and increases the relative size of the nonmonitoring banking system and the probability of failure of monitoring banks. We also show that the dynamic version of the model exhibits endogenous boom and bust cycles, and rationalizes the existence of countercyclical risk premia and the connection between low interest rates, tight credit spreads, and the buildup of risks during booms.

Credit Growth, the Yield Curve and Financial Crisis Prediction: Evidence from a Machine Learning Approach

“…But, only a few studies have have linked it empirically to the risk of financial crises and these studies have not discussed this result in detail or examined the role of the yield curve on the global level (Babeckỳ et al, 2014;Joy et al, 2017;Vermeulen et al, 2015). At the same time, our work is compatible with several theoretical models which investigate the relationships between nominal risk-free returns, risk taking, credit and financial stability (Aikman et al, 2015;Martinez-Miera and Repullo, 2017;Coimbra and Rey, 2017;Korinek and Novak, 2017). These models tend to highlight the importance of credit booms, particularly in a low interest rate environment, counter-cyclical risk premia and searchfor-yield behaviour prior to financial crises.…”

Interest Rates and Investment Under Competitive Screening and Moral Hazard

“… Dell'Ariccia, Laeven, and Marquez (2014) and Bolton, Santos, and Scheinkman (2016b), building on Bolton, Santos, and Scheinkman (2016a) andMartinez-Miera and Repullo (2017), provide microfoundations for this argument.…”

Monetary Policy, Macroprudential Policy, and Financial Stability

“…Our main building block is the setup of Martinez-Miera and Repullo (2017), in which competitive …nancial institutions that are funded with uninsured debt can monitor entrepreneurial …rms at a cost. Monitoring is costly and unobservable, so there is a moral hazard problem.…”

“…Alternatively, we could simply assume that the central bank sells its own liabilities (reserves remunerated at market rates) to investors.10 An expansionary monetary policy would lead to the opposite results, in line with the e¤ects of a savings glut analyzed in Martinez-Miera andRepullo (2017).ECB Working Paper Series No 2297 / July 2019…”