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Bailouts, Contagion, and Bank Risk-Taking

Lev Ratnovski () and Giovanni Dell'ariccia ()

No 133, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: We revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks (bailout) creates moral hazard and encourages risk-taking. However, when a bank's success depends on both its idiosyncratic risk and the overall stability of the banking system, a government's commitment to shield banks from contagion may increase their incentives to invest prudently. We explore these issues in a simple model of financial intermediation where a bank's survival depends on another bank's success. We show that the positive effect from systemic insurance dominates the classical moral hazard effect when the risk of contagion is high.

New Economics Papers: this item is included in nep-ban, nep-cba, nep-cta and nep-rmg
Date: 2012
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More papers in 2012 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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