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The Financial and Macroeconomic Implications of Banking Frictions and Banking Riskiness

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  • Yi Jin
  • Zhixiong Zeng

Abstract

This paper develops a model of banking frictions and banking riskiness, the importance of which is highlighted by the recent Global Financial Crisis (GFC). We propose a model-based approach to decompose the effect of a banking riskiness shock into a pure default effect and a risk effect when risk sharing among the depositors is imperfect. Although the default effect is quantitatively more important, the risk effect is not to be neglected. When the shock generates a bank spread similar in value to the peak during the GFC, the overall effect is a decline in employment by 6:57 percent. The pure default effect leads to a 4:76 percent employment decline by a “within-model” measure, and a 5:05 decline by a “between-model” measure. The remaining is attributed to the risk effect.

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File URL: http://www.buseco.monash.edu.au/eco/research/papers/2011/1411financialandmacrojinzen.pdf
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Bibliographic Info

Paper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number 14-11.

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Length: 40 pages
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:mos:moswps:2011-14

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Related research

Keywords: Banking riskiness shocks; two-sided debt contract; default effects; risk effects; financial crisis.;

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  1. Zeng, Zhixiong, 2010. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," MPRA Paper 24752, University Library of Munich, Germany.
  2. Stephen D. Williamson, 1989. "Restrictions on financial intermediaries and implications for aggregate fluctuations: Canada and the United States, 1870-1913," Staff Report 119, Federal Reserve Bank of Minneapolis.
  3. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-49, October.
  4. Zhixiong Zeng, 2007. "The price of size and financial market allocations," Economic Theory, Springer, vol. 30(1), pages 21-48, January.
  5. Cerasi, Vittoria & Daltung, Sonja, 2000. "The optimal size of a bank: Costs and benefits of diversification," European Economic Review, Elsevier, vol. 44(9), pages 1701-1726, October.
  6. Hellwig, Martin F, 2000. "Financial Intermediation with Risk Aversion," Review of Economic Studies, Wiley Blackwell, vol. 67(4), pages 719-42, October.
  7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  8. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
  9. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May.
  10. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  11. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
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