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Too-many-to-fail and the Design of Bailout Regimes

Author

Listed:
  • Wolf Wagner

    (Erasmus University and CEPR)

  • Jing Zeng

    (University of Bonn and CEPR)

Abstract

We analyze the design of bailout regimes when investment is distorted by a too-many-to-fail problem. The first-best allocation equalizes benefits from more banks investing in high-return projects with endogenously higher systemic risk due to more banks failing simultaneously. A standard bailout policy cannot implement the first-best, as bailouts cause herding by banks. However, a bailout policy that assigns banks to separate bailout regimes eliminates herding and achieves the first-best. When such a policy is not feasible, targeted bailouts can be implemented by decentralizing bailout decisions to independent regulators. Our results have various implications for the optimal allocation of regulatory powers, both at the international level and domestically.

Suggested Citation

  • Wolf Wagner & Jing Zeng, 2023. "Too-many-to-fail and the Design of Bailout Regimes," ECONtribute Discussion Papers Series 230, University of Bonn and University of Cologne, Germany.
    • Handle: RePEc:ajk:ajkdps:230
    as

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    File URL: https://www.econtribute.de/RePEc/ajk/ajkdps/ECONtribute_230_2023.pdf
    File Function: First version, 2023
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    systemic risk; too-many-to-fail; optimal investment; bailouts;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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