Bailouts, Contagion, and Bank Risk-Taking
We revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks (bailout) creates moral hazard and encourages risk-taking. However, when a bank's success depends on both its idiosyncratic risk and the overall stability of the banking system, a government's commitment to shield banks from contagion may increase their incentives to invest prudently. We explore these issues in a simple model of financial intermediation where a bank's survival depends on another bank's success. We show that the positive effect from systemic insurance dominates the classical moral hazard effect when the risk of contagion is high.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
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