Macroeconomic uncertainty and banks' lending decisions: The case of Italy

Abstract

This paper discusses the role that macroeconomic uncertainty plays in banksÂ’ decisions on the optimal asset allocation. Using a portfolio model recently proposed in the literature, the paper aims at disentangling how Italian banks choose between loans and risk-free assets when uncertainty on macroeconomic conditions increases. The econometric results confirm that macroeconomic uncertainty is a significant determinant of banksÂ’ investment decisions, also after controlling for other factors. In periods of increasing turmoil, banksÂ’ ability to accurately forecast future returns is hindered and herding behaviour tends to emerge, as witnessed by the reduction of the cross-sectional variance of the share of loans held in portfolio.bank, business cycle, uncertainty, lending decisions, GARCH