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Banks, Relative Performance, and Sequential Contagion

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  • Sudipto Bhattacharya
  • Charles A. E. Goodhart
  • Pojanart Sunirand
  • Dimitrios P. Tsomocos

Abstract

We develop a multi-period general equilibrium model of bank deposit, credit, and interim inter-bank loan markets in which banks initially specialize in their choices of debtors, leading to under-diversification, but nevertheless become entwined via inter-bank markets, leading to the fortunes of one bank affecting the profits and default rates of the other in a sequential manner. Lack of (full) diversification among credit risks arises in our model owing to a relative profit argument in each banker's utility function, which is otherwise risk- and default-averse. We examine its implications for the welfare of depositors and debtors.

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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2006fe10.

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Length: 15
Date of creation: 2006
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Handle: RePEc:sbs:wpsefe:2006fe10

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  1. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer, vol. 27(1), pages 107-142, 01.
  2. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304, Cowles Foundation for Research in Economics, Yale University.
  3. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  4. Prat, Andrea & Dasgupta, Amil, 2006. "Financial equilibrium with career concerns," Theoretical Economics, Econometric Society, vol. 1(1), pages 67-93, March.
  5. Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
  6. Dimitrios P. Tsomocos, 2003. "Equilibrium Analysis, Banking and Financial Instability," OFRC Working Papers Series 2003fe08, Oxford Financial Research Centre.
  7. Franklin Allen & Douglas Gale, 2000. "Financial Contagion," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 1-33, February.
  8. Hvide, Hans K. & Kristiansen, Eirik G., 2003. "Risk taking in selection contests," Games and Economic Behavior, Elsevier, vol. 42(1), pages 172-179, January.
  9. Acharya, Viral V., 2009. "A Theory of Systemic Risk and Design of Prudential Bank Regulation," CEPR Discussion Papers 7164, C.E.P.R. Discussion Papers.
  10. Dimitrios P Tsomocos & Charles A.E. Goodhart, 2004. "A Model to Analyse Financial Fragility: Applications," Economics Series Working Papers 2004-FE-05, University of Oxford, Department of Economics.
  11. Isabel Schnabel & Hyun Song Shin, 2004. "Liquidity and Contagion: The Crisis of 1763," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 929-968, December.
  12. M. Shubik & D. Tsomocos, 1992. "A strategic market game with a mutual bank with fractional reserves and redemption in gold," Journal of Economics, Springer, vol. 55(2), pages 123-150, June.
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Cited by:
  1. Charles Goodhart & Dimitrios Tsomocos & Pojanart Sunirand, 2008. "The Optimal Monetary Instrument for Prudential Purposes," FMG Discussion Papers dp617, Financial Markets Group.
  2. Benjamin Tabak & Daniel Cajueiro & Dimas Fazio, 2013. "Financial fragility in a general equilibrium model: the Brazilian case," Annals of Finance, Springer, vol. 9(3), pages 519-541, August.
  3. Dmitry Levando, 2012. "A Survey Of Strategic Market Games," Economic Annals, Faculty of Economics, University of Belgrade, vol. 57(194), pages 63-106, July - Se.
  4. Sudipto Bhattacharya & Charles Goodhart & Dimitrios Tsomocos & Alexandros Vardoulakis, 2011. "Minsky’s Financial Instability Hypothesis and the Leverage Cycle," FMG Special Papers sp202, Financial Markets Group.

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