Pietro Veronesi (Chicago Booth)

Option-based Pseudo Banks

Abstract. We use the notion of pseudo firms (Culp, Nozawa, and Veronesi, 2018) to build a fictitious but empirically observable macro-economy in which pseudo firms invest in observable investment assets (shares of traded companies) financing those investments by borrowing from fictitious pseudo banks. Pseudo banks’ assets are then comprised by observable pseudo bonds, that is, portfolios of risk-free bonds minus traded put options written on the underlying shares. All shocks in the pseudo economy — with their empirical distributions — are observable at high frequency. We assess the impact of shocks to pseudo firms’ fundamentals on the pseudo banks. The distribution of pseudo banks’ asset returns is strongly negatively skewed and leptokurtic, even for pseudo banks that make relatively safe pseudo loans. The 2008 shock induced joint defaults of pseudo banks, even when pseudo banks’ loans are randomly assigned to pseudo firms. Even a conservative threshold for capital requirement calibrated to the 2008 crisis, including countercyclical capital buffers, would have not spared the (pseudo) banking system from the 2020 Covid shock, highlighting the importance of the indirect government support to the banking system in 2020.

Joint with Yoshio Nozawa.