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Collective Moral Hazard and the Interbank Market

Levent Altinoglu and Joseph Stiglitz
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Levent Altinoglu: https://www.federalreserve.gov/econres/levent-altinoglu.htm

No 2020-098, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.

Keywords: Systemic risk; systemically important financial institutions (SIFI); Interbank markets; Financial crises; Bailouts; Macroprudential supervision (search for similar items in EconPapers)
JEL-codes: E61 G01 G18 G21 G28 (search for similar items in EconPapers)
Pages: 60
Date: 2020-12-02
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cta, nep-fdg, nep-mac and nep-rmg
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https://www.federalreserve.gov/econres/feds/files/2020098pap.pdf (application/pdf)

Related works:
Journal Article: Collective Moral Hazard and the Interbank Market (2023) Downloads
Working Paper: Collective Moral Hazard and the Interbank Market (2022) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2020-98

DOI: 10.17016/FEDS.2020.098

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