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Financial innovation, macroeconomic stability and systemic crises

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Author Info
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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Paper provided by Bank of England in its series Bank of England working papers with number 340.

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Handle: RePEc:boe:boeewp:340

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    • Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November. [Downloadable!] (restricted)
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  8. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
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  13. 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. [Downloadable!] (restricted)
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  14. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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  15. Prasanna Gai & Peter Kondor & Nicholas Vause, . "Procyclicality, collateral values and financial stability," Bank of England working papers 304, Bank of England. [Downloadable!]
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  17. Allen, Franklin & Carletti, Elena, 2006. "Credit risk transfer and contagion," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 89-111, January. [Downloadable!] (restricted)
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