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Financial liberalization and contagion with unobservable savings

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  • Panetti, Ettore

Abstract

How do market-based channels for the provision of liquidity affect financial liberalization and contagion? In order to answer this question, I extend the Diamond and Dybvig (1983) model of financial intermediation to a two-country environment with unobservable markets for borrowing and lending and comparative advantages in the investment technologies. I demonstrate that the role of hidden markets crucially depends on the level of financial integration of the economy. Despite always imposing a burden on intermediaries, unobservable markets allow agents to partially enjoy gains from financial integration when interbank markets are autarkic. In fully liberalized systems such effect instead disappears. Similarly, in autarky the distortion created by hidden markets improve the resilience of the system to unexpected liquidity shocks. With fully integrated interbank markets, such effect again disappears, as unexpected liquidity shocks always lead to bankruptcy and contagion.

Suggested Citation

  • Panetti, Ettore, 2011. "Financial liberalization and contagion with unobservable savings," MPRA Paper 29540, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:29540
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    References listed on IDEAS

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    Cited by:

    1. Ettore Panetti, 2017. "A Theory of Bank Illiquidity and Default with Hidden Trades," Review of Finance, European Finance Association, vol. 21(3), pages 1123-1157.
    2. Panetti, Ettore, 2011. "Unobservable savings, risk sharing and default in the financial system," MPRA Paper 29542, University Library of Munich, Germany.

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    More about this item

    Keywords

    financial intermediation; financial liberalization; financial contagion; unobservable savings;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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