Page 311 - Special Topic Session (STS) - Volume 1

STS441 Giulio B. et al.
1. Introduction
Fire sales are considered as one of the major channels of financial
contagion (see Shleifer and Vishny (2011) for a comprehensive survey). In the
euro area, fire sales of sovereign bonds have been pointed out as a main driver
of systemic risk in the financial system and a key vulnerability of the banking
sector (see, for instance, Greenwood et al. (2015)). Fire sales of sovereign
bonds by distressed banks are also seen as a key element in the vicious circle
linking banking and sovereign debt crises and contributing to an inherently
fragile financial system (see Cooper and Nikolov (2018)). As a consequence,
regulators call for minimum capital requirements underlying banks’ sovereign
bond holdings (see, for example, European Systemic Risk Board (2015)) in
order to mitigate fire-sale contagion and the doom loop between banking and
sovereign defaults. At the same time, though, recent research highlights that
a bank can opportunistically steer its customers’ portfolios towards assets
which the bank intends to sell off from its proprietary trading portfolio (see
Fecht et al. (2018)). This suggests that banks which dispose of a large customer
base and/or manage considerable wealth on behalf of customers might be
able to mitigate fire-sale pricing by pushing those sovereign bonds that the
bank intends to liquidate to bank-affiliated mutual funds or directly to their
retail customers.
In this paper, we test this hypothesis using a unique dataset from the
Deutsche Bundesbank that allows us to match for the period 2009Q3–2016Q1
security-level data on all German banks’ proprietary sovereign bond holdings
with the respective security holdings of the bank’s affiliated mutual funds (if it
has any) as well as the holdings of its retail customers. As a proxy for the time-
varying riskiness of a particular country’s sovereign, we use credit default swap
spread data from Markit at maturities matched to those of the individual
1
sovereign bond.
In a fist set of panel regressions, we find that whenever a bank sells a risky
sovereign bond during the crisis the changes in the bank’s holdings are
negatively correlated with both its retail customers’ and its affiliated mutual
funds’ holdings of the same bond. This negative correlation increases the
riskier the respective sovereign bond. These findings hold even if we fully
saturate the model with time-varying security, time-varying bank (or fund) and
bank (or fund)-security fixed effects to account for market wide changes in
funds’ (households’) risky bond investments, changes in a mutual funds’ (bank
customers’) overall bond purchase and persistent differences in fund (bank
customers’) specific investments in certain bonds. Our findings are particularly

1 We use the CDS on senior debt of the country with six different maturities (1y, 2y, 3y, 5y, 7y
and 10y. In a robustness check, we also use the official credit ratings from S&P, Moody’s and
Fitch.
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