Unexpected Loan Losses and Bank Capital in an Estimated DSGE Model of the Euro Area

52 Pages Posted: 5 Dec 2016

See all articles by Nikolay Hristov

Nikolay Hristov

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Oliver Hülsewig

Munich University of Applied Sciences; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: October 2016

Abstract

We develop a stylized DSGE model in which banks face capital regulation and their loan portfolios are subject to non-diversifiable losses due to aggregate shocks. The framework is used to explore the importance of the interaction between macroeconomic conditions, credit default and bank capitalization for the transmission of macroeconomic shocks. We fit the model to euro area data. Impulse response analysis shows that the aforementioned interaction substantially magnifies the responsiveness of the economy to real and nominal demand side disturbances. The amplification is especially strong with respect to government spending shocks. The model is further capable of replicating two financial market characteristics that are documented in the empirical literature, i.e. the pro-cyclicality of bank profitability and the counter-cyclical response of firm default rates and credit spreads to monetary policy shocks.

Keywords: DSGE model, bank capital, aggregate loan losses, business cycle fluctuations

JEL Classification: E440, E510, G210, G330

Suggested Citation

Hristov, Nikolay and Hülsewig, Oliver, Unexpected Loan Losses and Bank Capital in an Estimated DSGE Model of the Euro Area (October 2016). CESifo Working Paper Series No. 6160, Available at SSRN: https://ssrn.com/abstract=2880361 or http://dx.doi.org/10.2139/ssrn.2880361

Nikolay Hristov (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

Oliver Hülsewig

Munich University of Applied Sciences ( email )

Munich
Germany

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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