Does risk aversion affect bank output loss? The case of the Eurozone

Abstract

We propose a new model to infer the evolution of bank-specific output losses due to the uncertainty in bank output prices. Losses are based on bank risk aversion with micro foundations tethered to the uncertainty regarding prices. Our model allows us to measure time-varying bank-specific output losses and risk aversion while taking into account all bank cross-sectional heterogeneity. We employ a panel data set to estimate the input and output elasticities with both parametric and non-parametric techniques. We are the first to document that increasing risk aversion among Eurozone banks during the financial crisis resulted in sizable output losses. Although subdued thereafter, losses have been resurging in recent years. Both conventional and unconventional monetary policy responses by the European Central Bank (ECB) mitigated uncertainty in bank output prices, though unequally so across countries. Certain measures of unconventional monetary policy may have even enhanced bank risk aversion and thereby output losses, but mainly so for large countries.