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Financial integration and systemic risk

  • Fecht, Falko
  • Grüner, Hans Peter

Recent empirical studies criticize the sluggish financial integration in the euro area and find that only interbank money markets are fully integrated so far. This paper studies the optimal regional and/or sectoral integration of financial systems given that integration is restricted to the interbank market. Based on Allen and Gale (2000)'s seminal analysis of financial contagion we derive the interbank market structure that maximizes consumers' ex-ante expected utility, i.e. that optimizes the trade-off between the contagion and the diversification effect. We analyze the impact of various structural parameters including the underlying stochastic structure on this trade-off. In addition we derive the efficient design of the interbank market that allows for a cross-regional risk sharing between banks. We also provide a measure for the efficiency losses that result if financial integration is limited to an integration of the interbank market.

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2005,11.

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Date of creation: 2005
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Handle: RePEc:zbw:bubdp2:4266
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  1. Freixas, Xavier & Parigi, Bruno & Rochet, Jean-Charles, 1999. "Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank," CEPR Discussion Papers 2325, C.E.P.R. Discussion Papers.
  2. Lieven Baele & Annalisa Ferrando & Peter Hördahl & Elizaveta Krylova & Cyril Monnet, 2004. "Measuring financial integration in the euro area," Occasional Paper Series 14, European Central Bank.
  3. Hartmann, Philipp & Manna, Michele & Manzanares, Andres, 2001. "The microstructure of the euro money market," Journal of International Money and Finance, Elsevier, vol. 20(6), pages 895-948, November.
  4. Falko Fecht & Kevin Huang, 2004. "Financial intermediaries, markets, and growth," Econometric Society 2004 North American Summer Meetings 419, Econometric Society.
  5. John Y. Campbell & Jens Hilscher & Jan Szilagyi, 2006. "In Search of Distress Risk," NBER Working Papers 12362, National Bureau of Economic Research, Inc.
  6. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Hamerle, Alfred & Liebig, Thilo & Scheule, Harald, 2004. "Forecasting Credit Portfolio Risk," Discussion Paper Series 2: Banking and Financial Studies 2004,01, Deutsche Bundesbank, Research Centre.
  8. Koetter, Michael & Bos, Jaap W. B. & Heid, Frank & Kool, Clemens J. M. & Kolari, James W. & Porath, Daniel, 2005. "Accounting for distress in bank mergers," Discussion Paper Series 2: Banking and Financial Studies 2005,09, Deutsche Bundesbank, Research Centre.
  9. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
  10. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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