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

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  1. 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.
  2. Zhixiong Zeng, 2004. "The Price Of Size And Financial Market Allocations," Royal Economic Society Annual Conference 2004, Royal Economic Society 86, Royal Economic Society.
  3. V. Cerasi & S. Daltung, 1995. "The Optimal Size of a Bank: Costs and Benefits of Diversification," Departmental Working Papers, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano 1995-05, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
  4. Zeng, Zhixiong, 2011. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," MPRA Paper 33471, University Library of Munich, Germany.
  5. Hellwig, Martin F, 2000. "Financial Intermediation with Risk Aversion," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 67(4), pages 719-42, October.
  6. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, Elsevier, vol. 18(2), pages 159-179, September.
  7. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(2), pages 399-415, May.
  8. 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.
  9. Stephen D. Williamson, 1989. "Restrictions on Financial Intermediaries and Implications for Aggregate Fluctuations: Canada and the United States 1870-1913," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 303-350 National Bureau of Economic Research, Inc.
  10. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, Econometric Society, vol. 68(1), pages 119-134, January.
  11. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
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