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Monitoring, liquidity provision and financial crisis

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Author Info

  • Mundaca, B. Gabriela

    ()
    (Ragnar Frisch Centre for Economic Research)

Abstract

This paper analyzes central bank policies on monitoring banks in distress when liquidity provisions are conditional on performance and a bad shock occurs. A sequential game model is used to analyze two policies: one in which the central bank acts with discretion and the second in which the optimal monitoring policy rule is made public. The results show that banks exert less effort and take higher risks with discretionary monitoring policy. With public information about monitoring rules, there is more central bank monitoring and less need to provide emergency financing. Public information about monitoring resolves the multiple equilibria that arise with discretion and a unique equilibrium emerges where the probability of banking crisis is reduced.

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File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2007/Memo-04-2007.pdf
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Bibliographic Info

Paper provided by Oslo University, Department of Economics in its series Memorandum with number 04/2007.

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Length: 33 pages
Date of creation: 10 Jan 2007
Date of revision: 01 Mar 2009
Handle: RePEc:hhs:osloec:2007_004

Contact details of provider:
Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Phone: 22 85 51 27
Fax: 22 85 50 35
Email:
Web page: http://www.oekonomi.uio.no/indexe.html
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Related research

Keywords: Monitoring; bailouts; banking crises; commitments; conditionality;

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References

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  1. Michael D. Bordo & Anna J. Schwartz, 2000. "Measuring Real Economic Effects of Bailouts: Historical Perspectives on How Countries in Financial Distress Have Fared With and Without Bailouts," NBER Working Papers 7701, National Bureau of Economic Research, Inc.
  2. Rochet, Jean-Charles & Vives, Xavier, 2002. "Coordination failures and the lender of last resort : was Bagehot right after all?," HWWA Discussion Papers 184, Hamburg Institute of International Economics (HWWA).
  3. George J. Mailath & Loretta J. Mester, 1993. "A positive analysis of bank closure," Working Papers 93-10/R, Federal Reserve Bank of Philadelphia.
  4. Rochet, Jean Charles & Vives, Xavier, 2002. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," CEPR Discussion Papers 3233, C.E.P.R. Discussion Papers.
  5. Acharya, Viral V. & Yorulmazer, Tanju, 2007. "Too many to fail--An analysis of time-inconsistency in bank closure policies," Journal of Financial Intermediation, Elsevier, vol. 16(1), pages 1-31, January.
  6. Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
  7. Eduardo Levy Yeyati & Tito Cordella, 1999. "Bank Bailouts: Moral Hazard vs. Value Effect," IMF Working Papers 99/106, International Monetary Fund.
  8. Cooper, Russell & Corbae, Dean, 2002. "Financial Collapse: A Lesson from the Great Depression," Journal of Economic Theory, Elsevier, vol. 107(2), pages 159-190, December.
  9. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
  10. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
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