Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/208229
Authors: 
Cooper, Russell W.
Nikolov, Kalin
Year of Publication: 
2018
Series/Report no.: 
ECB Working Paper 2195
Abstract: 
This paper studies the interaction of government debt and financial markets. This interaction, termed a "diabolic loop", is driven by government choice to bail out banks and the resulting incentives for banks to hold government debt rather than self-insure through equity buffers. We highlight the role of bank equity issuance in determining whether the "diabolic loop" is a Nash Equilibrium of the interaction between banks and the government. When equity is issued, no diabolic loop exists. In equilibrium, banks' rational expectations of a bailout ensure that no equity is issued and the sovereign-bank loop is operative.
Subjects: 
Sovereign default
Sovereign-banking loop
JEL: 
G01
G28
E44
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-3300-1
Document Type: 
Working Paper

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