Contagion and risk-sharing on the inter-bank market
AbstractIncreasing inter-bank lending has an ambiguous impact on financial stability. Two opposing effects have been identified: promoting stability through risk sharing and providing a channel through which contagion may spread. In this paper we identify the conditions under which each relationship holds. In response to large economy-wide shocks, greater numbers of inter-bank lending relationships are shown to worsen systemic events, however, for smaller shocks the opposite effect is observed. As such there is no optimal inter-bank market structure which maximizes stability under all conditions. In contrast, deposit insurance costs are always reduced under greater numbers of inter-bank lending relationships.
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Bibliographic InfoPaper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 11/10.
Date of creation: Nov 2010
Date of revision: Jan 2013
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Other versions of this item:
- Ladley, Daniel, 2013. "Contagion and risk-sharing on the inter-bank market," Journal of Economic Dynamics and Control, Elsevier, vol. 37(7), pages 1384-1400.
- Dan Ladley, 2010. "An economic model of contagion in interbank lending markets," Discussion Papers in Economics 11/06, Department of Economics, University of Leicester, revised Dec 2010.
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-01-30 (All new papers)
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