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Financial innovation, macroeconomic stability and systemic crises

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  • Prasanna Gai
  • Sujit Kapadia
  • Stephen Millard
  • Ander Perez

Abstract

We present a general equilibrium model of intermediation designed to capture some of the key features of the modern financial system. The model incorporates financial constraints and state-contingent contracts, and captures the spillovers associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, these spillovers can potentially generate a systemic financial crisis that may be self-fulfilling. Our model suggests that financial innovation and greater macroeconomic stability may have made financial crises in developed countries less likely than in the past, but potentially more severe.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2006)
Issue (Month): Nov ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2006:i:nov:x:17

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References

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  1. Hoggarth, Glenn & Reis, Ricardo & Saporta, Victoria, 2002. "Costs of banking system instability: Some empirical evidence," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 825-855, May.
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  10. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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  14. Morris, Stephen & Shin, Hyun Song, 1997. "Unique Equilibrium in a Model of Self-fulfilling Currency Attacks," CEPR Discussion Papers 1687, C.E.P.R. Discussion Papers.
  15. Prasanna Gai & Peter Kondor & Nicholas Vause, 2006. "Procyclicality, collateral values and financial stability," Bank of England working papers 304, Bank of England.
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Citations

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Cited by:
  1. Ilhyock Shim & Goetz von Peter, 2007. "Distress selling and asset market feedback," BIS Working Papers 229, Bank for International Settlements.
  2. Aikman, David & Alessandri, Piergiorgio & Eklund, Bruno & Gai, Prasanna & Kapadia, Sujit & Martin, Elizabeth & Mora, Nada & Sterne, Gabriel & Willison, Matthew, 2009. "Funding liquidity risk in a quantitative model of systemic stability," Bank of England working papers 372, Bank of England.
  3. Piergiorgio Alessandri & Prasanna Gai & Sujit Kapadia & Nada Mora & Claus Puhr, 2009. "Towards a Framework for Quantifying Systemic Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 5(3), pages 47-81, September.
  4. Frank A.G. den Butter, 2010. "The Macroeconomics of the Credit Crisis: In Search of Externalities for Macro-Prudential Supervision," Tinbergen Institute Discussion Papers 10-052/3, Tinbergen Institute.
  5. Miller, Marcus & Stiglitz, Joseph E, 2009. "Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?," CEPR Discussion Papers 7469, C.E.P.R. Discussion Papers.
  6. Lucas Bretschger & Vivien Kappel, 2010. "Market concentration and the likelihood of financial crises," CER-ETH Economics working paper series 10/138, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  7. Mirakhor, Abbas & Krichene, Noureddine, 2009. "The Recent Crisis: Lessons for Islamic Finance," MPRA Paper 56022, University Library of Munich, Germany.
  8. Rasmus Kattai, 2010. "Credit risk model for the Estonian banking sector," Bank of Estonia Working Papers wp2010-01, Bank of Estonia, revised 04 Feb 2010.
  9. Mariano Beltrani & Juan Cuattromo, 2012. "Redefining Monetary Policy Limits: Towards an Expansion of its Role in Economic Development," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(67), pages 121-168, December.
  10. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  11. Kara, Gazi, 2013. "Systemic Risk, International Regulation, and the Limits of Coordination," Finance and Economics Discussion Series 2013-87, Board of Governors of the Federal Reserve System (U.S.).
  12. David Mayes, 2011. "The future of financial markets: financial crisis avoidance," Empirica, Springer, vol. 38(1), pages 77-101, February.
  13. da Silva, Marcos Soares & Divino, Jose Angelo, 2013. "The role of banking regulation in an economy under credit risk and liquidity shock," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 266-281.

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