Financial Integration and Systemic Risk

Falko Fecht () and Hans Peter Grüner

No 5253, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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’s (2000) seminal analysis of financial contagion we derive the interbank market structure that maximizes consumers’ ex ante expected utility, taking into account the trade-off between the contagion and the diversification effect of financial integration. We analyse 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.

Keywords: financial contagion; financial integration; interbank market; risk sharing (search for similar items in EconPapers)
JEL-codes: D61 E44 G10 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-mac
Date: 2005-09
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Working Paper: Financial integration and systemic risk (2005)
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