Research

Working Papers

Fragmentation in euro area banks' sovereign portfolios and its impact on international pricing [Job Market Paper]

Draft available by email while the paper is under review by the European Central Bank (ECB), notwithstanding submitted in the applications. Please email me at alexia.ventula_veghazy@ecb.europa.eu for a draft. 

Leveraging on a confidential dataset of euro area banks’ portfolio holdings of government securities, I study the determinants of the deviations from covered interest rate parity (CIP), i.e., hedged euro-dollar yield differentials. First, I document stark fragmentation in banks’ holdings across different euro area countries. This suggests that country’s convenience yield and the characteristics of the banks holding the government bonds matter. Motivated by those facts, I estimate hedged euro-dollar yield differentials for euro area banks and find sizable and heterogeneous CIP deviations, despite their common currency. Decomposing the CIP into a risk-free interest rate differential and a convenience yield differential across currencies shows a convenience for holding dollars, albeit it differs across euro area regions. In a second stage, I link the CIP deviations to three factors: the cumulative asset purchases of government bonds from the ECB asset purchase programmes, bank home bias and regulatory constraints. The last two significantly explain the deviations from arbitrage, confirming the role of fragmented banking systems in affecting the transmission mechanism of a common monetary policy and providing supporting evidence for the emerging theoretical literature linking CIP and banks’ balance sheets.

Granular Investors and International Bond Prices: Scarcity-Induced Safety (with Ester Faia and Juliana Salomao) 

R&R AEJ: Macroeconomics

With a unique dataset of euro area corporate bonds, we study the role of large heterogeneous investors’ demand on currency pricing. We document that while insurance and pension funds exhibit strong preferences for holding assets issued by local firms and denominated in home currency; mutual funds do not. Motivated by this segmentation, we estimate the impact of investor demand on euro-dollar return differentials (hedged and unhedged) for given security and issuer. These differentials decline as ECB asset purchases induce a drain in euro securities. A dynamic portfolio optimization model of bonds in different currencies, where heterogeneous risk-attitudes lead to UIP deviations and regulation to CIP ones, accounts for the facts.

'Long GFC'? The Global Financial Crisis, Health Care, and COVID-19 Deaths (with Antonio Moreno, Steven Ongena, and Alexander F. Wagner) 

Conditionally accepted at Economic Inquiry

Do financial crises affect long-term public health? To answer this question, we study the connection between the 2007-2009 Global Financial Crisis (GFC) and the 2020-2022 pandemic. Specifically, we examine the relation between macroeconomic and financial losses derived from the GFC, and the health outcomes associated with the first wave of the pandemic. At the European level, countries more affected by the financial crisis had more deaths relative to coronavirus cases. An analogous relation emerges across Spanish provinces and US states. Part of the transmission from finance to health outcomes appears to have occurred through cross-sectional differences in health care facilities.

Quantitative Easing and the Safe Asset Illusion (with Alexander Bechtel, Jens Eisenschmidt, and Angelo Ranaldo) 

Working Papers on Finance No. 2021/10, University of St. Gallen

The massive recourse to quantitative easing (QE) calls for a better understanding of its effects on safe assets. Based on a simple balance sheet framework, we show how QE impacts the total amount, cross-sectional distribution, and composition of safe assets in the economy. Analyzing the ECB’s Public Sector Purchase Programme (PSPP), we find that the amount of universally accessible safe assets decreases and there is a transfer of safe assets from the non-bank to the banking sector. We call this phenomenon the safe asset illusion. The sectoral shift in the holding structure of safe assets has important implications for financial stability and the cost of secured liquidity.

The Implications of Liquidity Regulation for Monetary Policy Implementation and the Central Bank Balance Sheet Size: An Empirical Analysis of the Euro Area (with Danielle Kedan) 

ECB Working Paper Series 2021/2515

We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation.

Policy Papers

Central Bank Digital Currency and Bank Intermediation  

ECB Occasional Paper No 293/May 2022

In July 2021 the Eurosystem decided to launch the investigation phase of the digital euro project, which aims to provide euro area citizens with access to central bank money in an increasingly digitalised world. While a digital euro could offer a wide range of benefits, it could prompt changes in the demand for bank deposits and services from private financial entities (ECB, 2020a), with knock-on consequences for bank lending and resilience. By inducing bank disintermediation, a central bank digital currency, or CBDC, could in principle alter the transmission of monetary policy and impact financial stability. To prevent this risk, options to moderate CBDC take-up are being discussed widely. In view of the significant degree of uncertainty surrounding the design of a potential digital euro, its demand and the prevailing environment in which it would be introduced, this paper explores a set of analytical exercises that can offer insights into the consequences it could have for bank intermediation in the euro area. Based on assumptions about the degree of substitution between different forms of money in normal times, several take-up scenarios are calculated to illustrate how the potential demand for a digital euro might shape up. The paper then analyses the mechanisms through which commercial banks and the central bank could react to the introduction of a digital euro. Overall, effects on bank intermediation are found to vary across credit institutions in normal times and to be potentially larger in stressed times. Further, a potential digital euro’s capacity to alter system-wide bank run dynamics appears to depend on a few crucial factors, such as CBDC remuneration and usage limits.