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Banks, relative performance, and sequential contagion

  • Sudipto Bhattacharya
  • Charles Goodhart
  • Pojanart Sunirand
  • Dimitrios Tsomocos

    ()

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 underdiversification, 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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File URL: http://hdl.handle.net/10.1007/s00199-007-0270-3
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Article provided by Springer in its journal Economic Theory.

Volume (Year): 33 (2007)
Issue (Month): 3 (December)
Pages: 601-601

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Handle: RePEc:spr:joecth:v:33:y:2007:i:3:p:601-601
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  1. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Dimitrios P Tsomocos, 2000. "Equilibrium Analysis, Banking and Financial Instability," Economics Series Working Papers 2003-FE-08, University of Oxford, Department of Economics.
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  4. 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.
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  7. 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.
  8. Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A model to analyse financial fragility: applications," LSE Research Online Documents on Economics 24680, London School of Economics and Political Science, LSE Library.
  9. 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.
  10. Franklin Allen & Douglas Gale, 1999. "Financial Contagion," Levine's Working Paper Archive 2092, David K. Levine.
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