DP12134 Balance-Sheet Diversification in General Equilibrium: Identification and Network Effects

Author(s): Jonas Heipertz, Amine Ouazad, Romain Rancière, Natacha Valla
Publication Date: July 2017
Keyword(s): Asset Pricing, Dynamic Factors., Financial Networks, General Equilibrium Model of Asset Trade, heterogenous beliefs
JEL(s): G01, G11, G12, G15, L14
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12134

The paper uses disaggregated data on asset holdings and liabilities to estimate a general equilibrium model where each institution determines the diversification and size of the asset and liability sides of its balance-sheet. The model endogenously generates two types of financial networks: (i) a network of institutions when two institutions share common asset or liability holdings or when an institution holds an asset that is the liability of another. In both cases demand/supply decisions by one institution affect the value of other institutions' holdings/liabilities, (ii) a network of financial instruments implied by the distribution of assets and liabilities within and across institutions. A change in the price of one asset induces change in demand/supply for all other assets, thus generating price comovement. The general equilibrium analysis predicts the propagation of real, financial and regulatory shocks as well as the change in the network caused by the shock.