Belief Mismatch and Banks’ Risk Taking: Evidence from the Repo Market in Mexico

Abstract

Belief mismatches can trigger endogenous credit constraints in short-term funding markets (Simsek (2013)), and if banks rely on the latter their risk taking can also be affected through different balance sheet channels (Dell’Ariccia et al. (2014)). Using proprietary data we propose a proxy for belief mismatches, between banks and open-ended funds in the repo market, and study the effect on the determination of the repo pricing, on different metrics of banks’ risk taking, and on loan prices. We show that optimistic banks attain collateral prices on average 16 basis points higher. In addition, they have leverage ratios an average of 11.4 basis points higher, and z-scores an average of 0.82 points lower. Finally, we find that the effect on banks of the monetary policy’s risk-taking channel is dampened when they are more optimistic than open-ended funds.