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Sovereign Defaults, Bank Runs, and Contagion

Listed author(s):
  • Stephan Luck

    ()

    (Max Planck Institute for Research on Collective Goods, Bonn)

  • Paul Schempp

    ()

    (Max Planck Institute for Research on Collective Goods, Bonn)

We provide a model that unifies the notion of self-fulfilling banking crises and sovereign debt crises. In this model, a bank run can be contagious by triggering a sovereign default, and vice versa. A deposit insurance scheme can eliminate the adverse equilibrium only if the government can repay its debt and credibly insure deposits irrespective of the performance of the financial sector. Moreover, we analyze how banking crises and sovereign defaults can be contagious across countries. We give conditions under which the implementation of a banking union is effective and costless. Finally, we discuss the current proposals for a banking union in the euro area and argue that it should be extended by a supranational Deposit Guarantee Scheme.

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File URL: http://www.coll.mpg.de/pdf_dat/2014_15online.pdf
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Paper provided by Max Planck Institute for Research on Collective Goods in its series Discussion Paper Series of the Max Planck Institute for Research on Collective Goods with number 2014_15.

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Date of creation: Sep 2014
Handle: RePEc:mpg:wpaper:2014_15
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  11. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Post-Print halshs-00492531, HAL.
  12. Stephan Luck & Paul Schempp, 2014. "Outside Liquidity, Rollover Risk, and Government Bonds," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2014_14, Max Planck Institute for Research on Collective Goods.
  13. Viral Acharya & Itamar Drechsler & Philipp Schnabl, 2014. "A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk," Journal of Finance, American Finance Association, vol. 69(6), pages 2689-2739, December.
  14. Philipp König & Kartik Anand & Frank Heinemann, 2013. "The ‘Celtic Crisis’: Guarantees, transparency, and systemic liquidity risk," SFB 649 Discussion Papers SFB649DP2013-025, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  15. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
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