Liquidity, Contagion and Financial Crisis

Guembel, Alexander and Sussman, Oren (2010) Liquidity, Contagion and Financial Crisis. TSE Working Paper, n. 10-240, Toulouse

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Official URL: http://tse-fr.eu/pub/24590

Abstract

We develop a theoretical model where a redistribution of bank capital (e.g., due to reckless trading and/or faulty risk management) leads to a “freeze” of the interbank market. The fire-sale market plays a central role in spreading the crisis to the real economy. In crisis, credit rationing
and liquidity hoarding appear simultaneously; endogenous levels of collateral (or margin requirements) are affected by both low fire-sale prices and high lending rates. Relative to previous analysis, this dual channel generates a stronger price and output effect. The main focus is on the policy analysis. We show that i) non-discriminating equity injections are more effective than liquidity injections, but in both the welfare effect is an order-of-magnitude lower than the price effect; ii) a discriminating policy that bails out only distressed banks is feasible but will be limited by incentive-compatibility constraints; iii) a restriction on international
capital flows has an ambiguous effect on welfare.

Item Type: Monograph (Working Paper)
Language: English
Date: 25 June 2010
Place of Publication: Toulouse
Uncontrolled Keywords: Debt deflation, Bailout, Liquidity Injection
JEL codes: G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G28 - Government Policy and Regulation
G33 - Bankruptcy; Liquidation
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse), TSM Research (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 18 Jan 2012 06:04
Last Modified: 20 Mar 2018 13:24
OAI ID: oai:tse-fr.eu:24590
URI: http://publications.ut-capitole.fr/id/eprint/3590

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