Government Intervention and Financial Fragility (job market paper)

This paper studies a model in which banks decide on the projects in which they invest, and the banks to which or from which they obtain loans. Thus, the links (network) created between banks is endogenous. Each bank is characterized by parameters which define the return on its projects, the withdrawal rate of its depositors and its equity available for investments. Maturity mismatch of balance sheets forces a fraction of assets to be prematurely liquidated, at a fire sale cost. The paper focuses on the impact of government intervention, which alleviates this cost by increasing the recovery rate of assets. The fragility of a network is measured by the number of bank failures following shocks of two kinds: first a shock to a single bank, second a simultaneous shock to all banks. The first leads to a ranking of the banks similar to that used by Google to rank websites: the higher its ranking the greater the degree of vulnerability induced by the bank. The vulnerability of the network to simultaneous shocks depends on the probability distribution of the banks characteristics: the more dispersed the distribution the greater its vulnerability. Government intervention increases the vulnerability of the network, the increase being greater the more dispersed the characteristics of the banks. Banking systems with similar leverage can have different degrees of vulnerability, highlighting the importance of networks. 

pdf / supplement /slides

Government Safety Net, Stock Market Participation and Asset Prices (work in progress)

This paper studies the effect on equilibrium prices adventing from the presence of a safety net during financial crises. It is shown that, by inflating prices with the insurance provided through its intervention policy, a government might be sowing the seeds of a crisis that its intention is to prevent in the first place. The model developed is one with risk-neutral agents facing a static decision problem, under different (i) frameworks - with and without the possibility of intervention - and (ii) informational scenarios - imperfect, perfect and common prior information. Intervention occurs whenever the combined return of those in the market goes below a certain threshold. By having different frameworks and scenarios, the impact of the safety net on a diverse class of assets can be studied. Equilibrium prices are shown to be always higher in the framework with the possibility of intervention, regardless of the informational scenario. There is a limit on price inflation, however, since an equilibrium fails to exist in those instances where high prices indicate an intervention to be imminent. The effect on prices of an increase in the degree of uncertainty turns out to be dependent on the supply level of the asset. 

pdf / slides

Government Induced Bubbles (work in progress)

We build a model of bubble inflation based on Morris and Shin (98), with investors deciding whether or not to buy an asset that entails the risk of a collapse in prices, in which case only government intervention could make them avoid a substantial loss. The more investors decide to buy, the more the bubble inflates, and government intervention takes place only when the collapse in prices is sufficiently large. In the benchmark scenario of common knowledge, self-fulfilling beliefs lead to multiplicity of equilibria. Using a global games approach, the introduction of a small noise in the signal received by the speculators yields a unique equilibrium, with intervention occuring only if the state of fundamentals happens to be higher than a particular threshold. In a comparative static exercise, it is shown that the government is more likely to step in and bubbles be large the less liquid the asset and the higher the aggregate wealth of investors.

pdf / slides

An Analysis of Home-Team Bias in the Brazilian Soccer League Using Panel Data (work in progress)

The literature on endogenous preference formation acknowledges that the social environment can aect individual behavior. In this spirit, sports, in particular soccer, constitute a natural setting where such a phenomenon can be studied. The present paper tests for the hypothesis of referees’ home team bias and the influence of the crowd on their behavior, using panel data collected from the brazilian soccer league of 2008. The variables focus of the analysis are amount of injury time, penalty kicks and red cards. Similarly to the results obtained in other leagues, the brazilian one also shows evidence of favoritism. In particular, the number of penalty kicks given to the home team is significatly larger than to the visitor, while the number of red cards is significantly smaller. Moreover, the referees tend to add more extra time when the home team is losing by one goal and less when it’s winning. The crowd doesn’t seem to exert any influence on the referees’ behavior. 


  • Danilo Lopomo Beteto