Equilibrium analysis, banking, contagion and financial fragility

Dimitrios Tsomocos

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper contains a general equilibrium model of an economy with incomplete markets (GEI) with money and default. The model is a simplified version of the real world consisting of a non-bank private sector, banks, a central bank, a government and a regulator. The model is used to analyse actions by policy-makers and to identify policy relevant empirical work. Key analytical results are: a financially fragile system need not collapse; efficiency can be improved with policy intervention; and a system with heterogeneous banks is more stable than one with homogeneous ones. Existence of monetary equilibria allows for positive default levels in equilibrium. It also characterises contagion and financial fragility as an equilibrium phenomenon. A definition of financial fragility is proposed. Financial fragility occurs when aggregate profitability of the banking sector declines and defaults in the non-bank and banking private sectors increase. Thus, equilibria with financial fragility require financial vulnerability in the banking sector and liquidity shortages in the non-bank private sector. The model will be used as a basis to carry out empirical work on the costs of financial instability, to quantify the effectiveness of particular regulatory tools such as capital requirements, and to identify trade-offs between increasing stability through action by authorities and the efficiency of the financial system.

Keywords: financial fragility; contagion; competitive banking; capital requirements; incomplete markets; default (search for similar items in EconPapers)
JEL-codes: D52 E4 E5 G1 G2 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2003-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (50)

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http://eprints.lse.ac.uk/24826/ Open access version. (application/pdf)

Related works:
Working Paper: Equilibrium analysis, banking, contagion and financial fragility (2003)
Working Paper: Equilibrium analysis, banking, contagion and financial fragility (2003)
Working Paper: Equilibrium Analysis, Banking, Contagion and Financial Fragility (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24826

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