The Transmission of Financial Shocks and Leverage of Banks: An Endogenous Regime Switching Framework

35 Pages Posted: 1 Feb 2021

See all articles by Kirstin Hubrich

Kirstin Hubrich

Board of Governors of the Federal Reserve System

Daniel F. Waggoner

Federal Reserve Bank of Atlanta

Date Written: December 23, 2020

Abstract

We investigate the transmission of financial shocks through the macroeconomy. To that end we develop an endogenous regime-switching structural vector autoregressive model with time-varying transition probabilities. First, we allow for the transition probabilities to be dependent on the state of the economy, and thereby to be time-varying. Second, we facilitate rather general, non-recursive structural identification restrictions. Third, we allow the identification restrictions to differ across regimes. We employ a model with conventional and unconventional monetary policy, where the latter is modelled via the Fed balance sheet. Using bank-level data, we shed light on the role of leverage of banks for the transmission of financial shocks.

Keywords: Regime Switching Models, Time-Varying Transition Probabilities, Financial Shocks, Leverage of Financial Institutions

JEL Classification: C11, C32, C53, E44, G21

Suggested Citation

Hubrich, Kirstin and Waggoner, Daniel F., The Transmission of Financial Shocks and Leverage of Banks: An Endogenous Regime Switching Framework (December 23, 2020). Available at SSRN: https://ssrn.com/abstract=3754617 or http://dx.doi.org/10.2139/ssrn.3754617

Kirstin Hubrich (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Daniel F. Waggoner

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States
404-521-8278 (Phone)

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