Thesis advisor: Susanto Basu / The goal of this dissertation is to shed some light on three separate aspects of the financial system that can lead to greater instability in the banking sector and greater macroeconomic volatility. The starting point of the Great Recession was the collapse of the banking sector in late 2007; in the subsequent months, liquidity evaporated in many markets for short term funding. The process of creating liquidity carried out by the banking system involves the transformation of long term illiquid assets into short term liquid liabilities. This engine functions properly as long as cash lenders continue to roll over short term funding to banks; whenever these lenders fear that banks will not be able to pay back these obligations, they immediately stop funding banks' short term liabilities. This makes banks unable to repay maturing short term debt, which leads to large spikes in default risk. This is often referred to as a modern bank run. Virtually all the theories of bank runs suggest that the severity of a run depends on how well lenders can coordinate their beliefs: whenever a lender expects many others to run, he becomes more likely to run as well. In a joint work with Emanuele Brancati, the first chapter of my dissertation, we empirically document the role of coordination in explaining bank runs and default risk. We establish two new results. First, when information is more precise and agents can better coordinate their actions, a change in market expectations has a larger impact on default risk; this implies that more precise information increases the vulnerability or instability of the banking system. This result has a clear policy implication: if policymakers want to stabilize the banking system they should promote opacity instead of transparency, especially during periods of financial turmoil. Second, we show that when a bank is expected to perform poorly, lower dispersion of beliefs actually increases default risk; this result is in contrast with standard theories in finance and can be rationalized by thinking about the impact that more precise information has on the ability of creditors to coordinate on a bank run. Another aspect of the banking system that is creating a lot of instability in Europe is the so called "disastrous banks-sovereign nexus": many banks in troubled countries owned a disproportionately large amount of domestic sovereign bonds; therefore, in case of a default of the sovereign country, the whole domestic banking sector would incur insurmountable losses. This behavior is puzzling because these banks in troubled countries would greatly benefit from having a more diversified asset portfolio, but instead decide to load up with domestic sovereign debt only. In a joint work with Filippo De Marco, the second chapter of my dissertation, we show that banks receive political pressures from their respective governments to load up on domestic sovereigns. First, we show that banks with a larger fraction of politicians as shareholders display greater home bias. More importantly, we exploit the fact that low-performing banks received liquidity injections by their domestic governments to show that, among those banks, only the "political banks" drastically increased their home bias upon receiving government help. Furthermore, it appears that the extent of political pressure on banks is much stronger on those "political banks" belonging to troubled countries. These findings suggest that troubled countries that would need to pay a high premium to issue new debt force their "political banks" to purchase part of the debt issuance. This greater risk-synchronization can create a dangerous loop of higher sovereign default risk leading to insolvency of the domestic banking system, which in turn would require a bail-out from the local government, further exacerbating the sovereign de- fault risk. Finally, the third chapter of my dissertation, a joint work with Susanto Basu, investigates the sources of excess consumption volatility in emerging markets. It is a well documented fact that, in emerging markets, consumption is more volatile than output whereas the opposite is true in developed economies. We propose an explanation for this phenomenon that relies on a specific form of financial markets incompleteness: we assume that households would always want to front-load consumption and they can borrow from abroad up to a fraction of the value of posted collateral. With the value of collateral being procyclical, households are able to increase borrowing during an expansion and ultimately consume more than they produce; this mechanism is then able to generate a ratio of consumption volatility to output volatility grater than one. Most importantly, the model delivers the implication that a better ability to borrow vis-a-vis the same value of collateral generates greater relative consumption volatility. We then bring this model's implication to the data and find empirical support for it. We proxy the ability to borrow with various measures of effectiveness of lending regulation and more standard indicators of financial development. Consistent with the model's implication, more lending friendly regulation leads to greater relative consumption volatility in emerging markets; moreover, this link breaks down among developed countries. In addition, among emerging countries, it appears that deeper domestic capital markets have a destabilizing effect in terms of greater relative consumption volatility while a more developed domestic banking system does not exerts any such detrimental effect. / Thesis (PhD) — Boston College, 2015. / Submitted to: Boston College. Graduate School of Arts and Sciences. / Discipline: Economics.