SUERF Policy Brief No. 662 on the Adoption, Fragility and Regulation of Stablecoins

This policy brief discusses the lessons for stablecoin adoption, fragility, and appropriate regulation through the lens of a theoretical model:

It is based on my recently published working paper: Christoph Bertsch (2023), “Stablecoins: Adoption and Fragility,” Sveriges Riksbank Working Paper Series, No. 423.

SUERF Policy Brief No. 528 on Fed Speeches Meet Transformer Models

This short policy article discusses the use of state-of-the-art methods from natural language processing to examine the evolution of the Fed’s interpretation of its mandate over time, using the largest corpus of Fed speeches assembled to-date:

It is based on our recently published working paper: Bertsch, Christoph, Hull, Isaiah, Lumsdaine, Robin L. and Xin Zhang (2022). “Central Bank Mandates and Monetary Policy Stances: through the Lens of Federal Reserve Speeches,” Sveriges Riksbank Working Paper Series No. 417, 2022:

New version of “Bank Misconduct and Online Lending”

“Bank Misconduct and Online Lending” with Isaiah Hull (Sveriges Riksbank), Yingjie Qi (Stockholm School of Economics) and Xin Zhang (Sveriges Riksbank)

  • Abstract:

We introduce a high quality proxy for bank misconduct that is constructed from
Consumer Financial Protection (CFPB) complaint data. We employ this proxy to
measure the impact of bank misconduct on the expansion of online lending in the
United States. Using nearly complete loan and application data from the online lending
market, we demonstrate that bank misconduct is associated with a statistically and
economically signi cant increase in online lending demand at the state and county
levels. This result is robust to the inclusion of bank credit supply shocks and holds for
both broader and more narrowly-de ned bank misconduct measures. Furthermore, we
show that this e ect is strongest for lower rated borrowers and weakest in states with
high levels of generalized trust.

  • Keywords: financial development, consumer loans, bank misconduct, FinTech.

Revised version of “Fire Sale Bank Recapitalizations”

“Optimal Bank Capitalization in Crowded Markets” with Mike Mariathasan (KU Leuven)
(This version: 08/2017; First version: 09/2015; Sveriges Riksbank Working Paper No. 312)

  • Abstract:

We study banks’ optimal equity buffer in general equilibrium, as well as their ex-post response to under-capitalization. Developing a “pecking order theory” for private recapitalizations, our benchmark model identifies equity issuance as individually and socially optimal, compared to deleveraging, and conditions that invert the individually optimal ranking. Ex-ante, the imperfectly elastic supply of capital, incomplete insurance markets and costly bankruptcies give rise to inefficiently high capital shortfalls and excessive insolvencies. Abstracting from moral hazard and informational asymmetries, we therefore provide a novel rationale for macroprudential capital regulation emerges and a new set of testable implications about banks’ capital structure management.

  • Keywords: bank capital, macroprudential regulation, incomplete markets, financial market segmentation, constrained inefficiency.

Revised version of a “A Wake-up Call Theory of Contagion”

“A wake-up call theory or contagion” with Toni Ahnert (Bank of Canada)
(This version: 05/2017; First version: 06/2012)

  • Abstract:

We offer a theory of contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions with an unobserved common macro shock as the only link between regions. A crisis in the first region is a wake-up call to investors in the second region. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can even occur after investors learn that regions are unrelated (zero macro shock). Our results rationalize empirical evidence about contagious bank runs and currency crises after wake-up calls. We also derive new implications and discuss how these can be tested. (JEL D82, F3, G01)

  • Keywords: wake-up call, information choice, financial crises, contagion, global games, regime change, fundamental re-assessment.

New paper on “Fire Sale Bank Recapitalizations”; Sveriges Riksbank Working Paper Series No. 312

“Fire Sale Bank Recapitalizations” with Mike Mariathasan (KU Leuven) (This version: Sept. 2015; First version: Sept. 2015)

  • Abstract:

We develop a general equilibrium model of banks’ capital structure, featuring heterogeneous portfolio risk and an imperfectly elastic supply of bank equity stemming from financial market segmentation. In our model, equity is costly and serves as a buffer against costly bankruptcy. Banks are ex-ante identical, but may need to recapitalize by selling equity claims after their portfolio risk becomes public knowledge. When the need to issue outside equity arises simultaneously in a large number of banks, the market for equity becomes crowded. Reminiscent of asset fire sales, banks do not fully internalize the effect of their individual equity issuance on the endogenous cost of equity and their future ability to recapitalize. As a result, they are under- capitalized in equilibrium, and the incidence of insolvency is inefficiently high. This constrained inefficiency provides a new rationale for macroprudential capital regulation that arises despite the absence of deposit insurance and moral hazard; it also has implications for the regulation of payout policies and the design of bank stress testing.

  • Keywords: macroprudential policy, capital regulation, capital structure, financial market segmentation, incomplete markets, constrained inefficiency.

Revised version of deleveraging paper; Sveriges Riksbank Working Paper Series No. 277

“A detrimental feedback loop: deleveraging and adverse selection” (This version: February 2015; First version: September 2013).

  • Abstract:
Market distress can be the catalyst of a deleveraging wave, as in the 2007/08 financial crisis. This paper demonstrates how market distress and financial sector deleveraging can fuel each other in the presence of adverse selection problems in an opaque asset market segment. At the core of the detrimental feedback loop is investors’ desire to reduce their reliance on the distressed opaque market by decreasing their leverage which in turn amplifies adverse selection in the opaque market segment. In the extreme, trade in the opaque asset market segment breaks down. I find that adverse selection is at the root of two inefficiencies: it distorts both investors’ long-term leverage choices and investors’ short-term liquidity management. I derive implications for central bank policy and highlight the ambiguous role played by transparency. (JEL D82, E58, G01, G20)

New publication: Lead article in The B.E. Journal of Economic Analysis & Policy (Advances)

“Systematic bailout guarantees and tacit coordination” with Claudio Calcagno and Mark Le Quement, The B.E. Journal of Economic Analysis & Policy (Advances), Volume 15, Issue 1, Pages 1-36, December 2014.

  • Abstract:

Both the academic literature and the policy debate on systematic bailout guarantees and Government subsidies have ignored an important effect: in industries where firms may go out of business due to idiosyncratic shocks, Governments may increase the likelihood of (tacit) coordination if they set up schemes that rescue failing firms. In a repeated-game setting, we show that a systematic bailout regime increases the expected profits from coordination and simultaneously raises the probability that competitors will remain in business and will thus be able to ’punish’ firms that deviate from coordinated behaviour. These effects make tacit coordination easier to sustain and have a detrimental impact on welfare. While the key insight holds across any industry, we study this question with an application to the banking sector, in light of the recent financial crisis and the extensive use of bailout schemes.