The Pecking Order of Segmentation and Liquidity-Injection Policies in a Model of Contagious Crises

Alexander Guembel () and Oren Sussman

The Review of Economic Studies, 2020, vol. 87, issue 3, 1296-1330

Abstract: We study a two-country setting in which leveraged investors generate fire-sale externalities, leading to financial crises and contagion. Governments can affect the incidence of financial crisis and the degree of contagion by injecting public liquidity and, additionally, by segmenting the countries' liquidity markets. We show that segmentation allows a country to avoid contagion and fend off mild financial crises caused by a small shock to its liquidity demand, at the cost of exposing it to more severe financial crises caused by a large shock. We derive a "pecking order" result, whereby segmentation is a second-best measure that coordinated governments should use only when tax capacity constrains them from injecting liquidity. Even when segmentation is welfare-enhancing, it should be applied to public liquidity alone, never restricting the free flow of private liquidity across countries. Uncoordinated governments tend to use segmentation excessively.

Keywords: Contagion; Fire sales; Financial crisis; Financial stability; Segmentation; Liquidity injection; G01; F32 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://hdl.handle.net/10.1093/restud/rdz015 (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: The Pecking Order of Segmentation and Liquidity-Injection Policies in a Model of Contagious Crises (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:87:y:2020:i:3:p:1296-1330.

Access Statistics for this article

The Review of Economic Studies is currently edited by Thomas Chaney, Xavier d’Haultfoeuille, Andrea Galeotti, Bård Harstad, Nir Jaimovich, Katrine Loken, Elias Papaioannou, Vincent Sterk and Noam Yuchtman

More articles in The Review of Economic Studies from Review of Economic Studies Ltd
Bibliographic data for series maintained by Oxford University Press ().