Bailouts, Contagion, and Bank Risk-Taking
AbstractWe revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks (bailout) creates moral hazard and encourages risk-taking. However, when a bank's success depends on both its idiosyncratic risk and the overall stability of the banking system, a government's commitment to shield banks from contagion may increase their incentives to invest prudently. We explore these issues in a simple model of financial intermediation where a bank's survival depends on another bank's success. We show that the positive effect from systemic insurance dominates the classical moral hazard effect when the risk of contagion is high.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 133.
Date of creation: 2012
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-11 (All new papers)
- NEP-BAN-2012-11-11 (Banking)
- NEP-CBA-2012-11-11 (Central Banking)
- NEP-CTA-2012-11-11 (Contract Theory & Applications)
- NEP-RMG-2012-11-11 (Risk Management)
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