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Financial liberalization and contagion with unobservable savings

  • Panetti, Ettore
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    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.

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    File URL: http://mpra.ub.uni-muenchen.de/29540/1/MPRA_paper_29540.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29540.

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    Date of creation: 01 Mar 2011
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    Handle: RePEc:pra:mprapa:29540
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    1. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2006. "A Theory of Liquidity and Regulation of Financial Intermediation," Levine's Bibliography 321307000000000326, UCLA Department of Economics.
    2. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, 07.
    3. Masami Imai & Seitaro Takarabe, 2011. "Bank Integration and Transmission of Financial Shocks: Evidence from Japan," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(1), pages 155-83, January.
    4. Mikhail Golosov & Aleh Tsyvinski, 2006. "Optimal Taxation with Endogenous Insurance Markets," Levine's Bibliography 784828000000000445, UCLA Department of Economics.
    5. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
    6. Rajkamal Iyer & José-Luis Peydró, 0. "Interbank Contagion at Work: Evidence from a Natural Experiment," Review of Financial Studies, Society for Financial Studies, vol. 24(4), pages 1337-1377.
    7. Zoltan Pozsar & Tobias Adrian & Adam Ashcraft & Hayley Boesky, 2010. "Shadow banking," Staff Reports 458, Federal Reserve Bank of New York.
    8. 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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