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Unobservable savings, risk sharing and default in the financial system

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  • Panetti, Ettore

Abstract

In the present paper, I analyze how unobservable savings affect risk sharing and bankruptcy decisions in the financial system. I extend the Diamond and Dybvig (1983) model of financial intermediation to an environment with heterogeneous intermediaries, aggregate uncertainty and agents' hidden borrowing and lending. I demonstrate three results. First, unobservability imposes a burden on financial intermediaries, that in equilibrium are not able to offer a banking contract that balances insurance and incentive motivations. Second, unobservable markets do induce default, but only as long as insurance markets are incomplete. Therefore, their presence is not a rationale for government intervention on bankruptcy via "resolution regimes". Third, even in case of complete markets the competitive equilibrium is inefficient, and a simple tier-1 capital ratio similar to the one proposed in the Basel III Accord implements the efficient allocation.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29542.

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Date of creation: 10 Feb 2011
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Handle: RePEc:pra:mprapa:29542

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Keywords: financial intermediation; hidden savings; bankruptcy; insurance; optimal regulation;

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References

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  1. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2006. "A Theory of Liquidity and Regulation of Financial Intermediation," Levine's Bibliography 321307000000000326, UCLA Department of Economics.
  2. Viral V. Acharya & Hamid Mehran & Anjan Thakor, 2010. "Caught between Scylla and Charybdis? Regulating bank leverage when there is rent seeking and risk shifting," Staff Reports 469, Federal Reserve Bank of New York.
  3. Pozsar, Zoltan & Adrian, Tobias & Ashcraft, Adam B. & Boesky, Hayley, 2013. "Shadow banking," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-16.
    • Zoltan Pozsar & Tobias Adrian & Adam Ashcraft & Hayley Boesky, 2010. "Shadow banking," Staff Reports 458, Federal Reserve Bank of New York.
  4. Panetti, Ettore, 2011. "Financial liberalization and contagion with unobservable savings," MPRA Paper 29540, University Library of Munich, Germany.
  5. Pricila Maziero, 2009. "Non-Exclusive Dynamic Contracts, Competition, and the Limits of Insurance," 2009 Meeting Papers 509, Society for Economic Dynamics.
  6. Cole, Harold L & Kocherlakota, Narayana R, 2001. "Efficient Allocations with Hidden Income and Hidden Storage," Review of Economic Studies, Wiley Blackwell, vol. 68(3), pages 523-42, July.
  7. Emmanuel Farhi & Jean Tirole, 2009. "Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts," NBER Working Papers 15138, National Bureau of Economic Research, Inc.
  8. Mikhail Golosov, 2007. "Optimal Taxation With Endogenous Insurance Markets," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 487-534, 05.
  9. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  10. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
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Cited by:
  1. Panetti, Ettore, 2011. "Financial liberalization and contagion with unobservable savings," MPRA Paper 29540, University Library of Munich, Germany.

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