Systemic Portfolio Diversification: Equilibrium Holdings and Policy Implications
Date/Time:13 Feb 2019 15:00Venue: S17 #04-06 SR1Speaker: Marko Hans Weber, Columbia UniversitySystemic Portfolio Diversification: Equilibrium Holdings and Policy ImplicationsWe study the implications of fire-sale externalities on optimal portfolio selection. Banks select their asset holdings to minimize expected execution costs triggered by the need to comply with regulatory leverage requirements. We show that if banks disregard the price impact caused by other banks’ liquidation actions, they hold an excessively diversified portfolio. Instead, banks seek systemic diversification when they account for other banks’ asset holdings: They reduce portfolio overlapping to decrease the likelihood of simultaneous deleveraging, sacrificing diversification benefits at the individual level. The bank’s equilibrium allocation is not socially efficient. A benevolent social planner aiming for minimum fire-sale externalities should provide incentives to increase banks’ diversity. A tax on portfolio overlaps aligns the private and social optimum. Social costs can be reduced by enforcing policies which mandate the split of a bank into smaller institutions with heterogeneous leverage ratios.Add to calendar:
