The Political Origin of Home Bias: The Case of Europe

Abstract

We show that politics is at the root of the banks-sovereign nexus that exacerbated the Eurozone crisis. First, government-owned banks or banks with politicians in the board of directors display higher home bias in sovereign debt compared to privately-owned banks throughout the 2010-2013 period. Second, only government-owned banks increased the home bias during the sovereign crisis (moral suasion). We exploit the fact that equity injections (bail-outs) by domestic governments were not directly targeted to political banks to show that, upon receiving such assistance, only government-owned banks purchase domestic debt. Such political pressure is stronger in countries under stress.

Keywords: Banks-sovereign nexus, Home Bias, Political Connections, Bail-outs and government-owned banks, Board of Directors

JEL Classification: G01, G11, D72