IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

A Model of Financial Fragility

Author Info

Listed author(s):
  • Lagunoff, Roger
  • Schreft, Stacey L.

Abstract

This paper presents a dynamic, stochastic game-theoretic model of financial fragility. The model has two essential features. First, interrelated portfolios and payment commitments forge financial linkages among agents. Second, iid shocks to investment projects’ operations at a single date cause some projects to fail. Investors who experience losses from project failures reallocate their portfolios, thereby breaking some linkages. In the Pareto-efficient symmetric equilibrium studied, two related types of financial crises can occur in response. One occurs gradually as defaults spread, causing even more links to break. An economy is more fragile ex post the more severe this financial crisis. The other type of crisis occurs instantaneously when forward-looking investors preemptively shift their wealth into a safe asset in anticipation of the contagion affecting them in the future. An economy is more fragile ex ante the earlier all of its linkages break from such a crisis. The paper also considers whether fragility is worse for larger economies.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/pii/S0022-0531(00)92733-9
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 99 (2001)
Issue (Month): 1-2 (July)
Pages: 220-264

as
in new window

Handle: RePEc:eee:jetheo:v:99:y:2001:i:1-2:p:220-264
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

Keywords:

Other versions of this item:

Find related papers by JEL classification:
  • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
  • G20 - Financial Economics - - Financial Institutions and Services - - - General

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Kreps, David M & Wilson, Robert, 1982. "Sequential Equilibria," Econometrica, Econometric Society, vol. 50(4), pages 863-894, July.
  2. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  3. J. M. Keynes, 1937. "The General Theory of Employment," The Quarterly Journal of Economics, Oxford University Press, vol. 51(2), pages 209-223.
  4. Atkeson, Andrew & Rios-Rull, Jose-Victor, 1996. "The balance of payments and borrowing constraints: An alternative view of the Mexican crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 331-349, November.
  5. Cooper, R. & Corbae, D., 1997. "Financial Fragility and the Great Depression," Working Papers 97-08, University of Iowa, Department of Economics.
  6. Franklin Allen & Douglas Gale, 2000. "Financial Contagion," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 1-33, February.
  7. Krasa, Stefan & Villamil, Anne P, 1992. "A Theory of Optimal Bank Size," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 725-749, October.
  8. Lagunoff, Roger & Schreft, Stacey L, 1999. "Financial Fragility with Rational And Irrational Exuberance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 531-560, August.
  9. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
  10. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
  11. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
  12. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  13. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
  14. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-762, November.
  15. Nobuhiro Kiyotaki & John Moore, 1997. "Credit Chains," ESE Discussion Papers 118, Edinburgh School of Economics, University of Edinburgh.
  16. Hiroshi Fujiki & Edward J. Green & Akira Yamazaki, 1999. "Sharing the risk of settlement failure," Working Papers 594, Federal Reserve Bank of Minneapolis.
  17. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
  18. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters,in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  19. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
Full references (including those not matched with items on IDEAS)

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

as
in new window


Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Access and download statistics

When requesting a correction, please mention this item's handle: RePEc:eee:jetheo:v:99:y:2001:i:1-2:p:220-264. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.