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A model to analyse financial fragility

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Author Info
Charles Goodhart
Pojanart Sunirand
Dimitrios Tsomocos ()

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Abstract

This paper sets out a tractable model which illuminates problems relating to individual bank behaviour, to possible contagious inter-relationships between banks, and to the appropriate design of prudential requirements and incentives to limit ‘excessive’ risk-taking. Our model is rich enough to include heterogeneous agents, endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable and can therefore be used as a practical framework to analyse financial fragility. Financial fragility in our model emerges naturally as an equilibrium phenomenon. Among other results, a non-trivial quantity theory of money is derived, liquidity and default premia co-determine interest rates, and both regulatory and monetary policies have non-neutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability and economic efficiency. Copyright Springer-Verlag Berlin/Heidelberg 2006

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File URL: http://hdl.handle.net/10.1007/s00199-004-0572-7
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Publisher Info
Article provided by Springer in its journal Economic Theory.

Volume (Year): 27 (2006)
Issue (Month): 1 (01)
Pages: 107-142
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Handle: RePEc:spr:joecth:v:27:y:2006:i:1:p:107-142

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Related research
Keywords: Financial fragility; Commerical banks; General equilibrium; Default; Incomplete markets; Monetary policy; Regulatory policy.;

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References listed on IDEAS
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  1. Tobin, James, 1982. " The Commercial Banking Firm: A Simple Model," Scandinavian Journal of Economics, Blackwell Publishing, vol. 84(4), pages 495-530.
  2. Geanakoplos, J. D. & Tsomocos, D. P., 2002. "International finance in general equilibrium," Research in Economics, Elsevier, vol. 56(1), pages 85-142, June. [Downloadable!] (restricted)
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  3. DREZE, Jacques & POLEMARCHAKIS, Heracles, 2000. "Monetary equilibria," CORE Discussion Papers 2000044, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
  4. Tsomocos, Dimitrios P., 2003. "Equilibrium analysis, banking and financial instability," Journal of Mathematical Economics, Elsevier, vol. 39(5-6), pages 619-655, July. [Downloadable!] (restricted)
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  5. Pradeep Dubey & John Geanakoplos, 2003. "Monetary Equilibrium with Missing Markets," Cowles Foundation Discussion Papers 1389, Cowles Foundation, Yale University. [Downloadable!]
  6. Haizhou Huang & Charles Goodhart, 1999. "A Model of the Lender of Last Resort," FMG Discussion Papers dp313, Financial Markets Group. [Downloadable!] (restricted)
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  7. Hool, Bryce, 1976. "Money, Expectations and the Existence of a Temporary Equilibrium," Review of Economic Studies, Blackwell Publishing, vol. 43(3), pages 439-45, October. [Downloadable!] (restricted)
  8. Grandmont, Jean-Michel & Younes, Yves, 1972. "On the Role of Money and the Existence of a Monetary Equilibrium," Review of Economic Studies, Blackwell Publishing, vol. 39(3), pages 355-72, July. [Downloadable!] (restricted)
  9. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April. [Downloadable!] (restricted)
  10. Grandmont, Jean-Michel & Laroque, Guy, 1975. "On Money and Banking," Review of Economic Studies, Blackwell Publishing, vol. 42(2), pages 207-36, April. [Downloadable!] (restricted)
  11. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2000. "Default in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers 1247, Cowles Foundation, Yale University. [Downloadable!]
  12. Dubey, Pradeep & Geanakoplos, John, 2003. "Monetary equilibrium with missing markets," Journal of Mathematical Economics, Elsevier, vol. 39(5-6), pages 585-618, July. [Downloadable!] (restricted)
  13. M. Shubik & D. Tsomocos, 1992. "A strategic market game with a mutual bank with fractional reserves and redemption in gold," Journal of Economics, Springer, vol. 55(2), pages 123-150, June. [Downloadable!] (restricted)
  14. Dimitrios Tsomocos, 2003. "Equilibrium Analysis, Banking, Contagion and Financial Fragility," OFRC Working Papers Series 2003fe03, Oxford Financial Research Centre. [Downloadable!]
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  15. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios Tsomocos, 2005. "Procyclicality and the new Basel Accord - banks’ choice of loan rating system," Economic Theory, Springer, vol. 26(3), pages 537-557, October. [Downloadable!] (restricted)
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  16. Geanakoplos, John, 1990. "An introduction to general equilibrium with incomplete asset markets," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 1-38. [Downloadable!] (restricted)
  17. Tomoyuki Nakajima & Herakles Polemarchakis, 2005. "Money and Prices Under Uncertainty," Review of Economic Studies, Blackwell Publishing, vol. 72(1), pages 223-246, 01. [Downloadable!] (restricted)
  18. James Tobin, 1963. "Commercial Banks as Creators of 'Money'," Cowles Foundation Discussion Papers 159, Cowles Foundation, Yale University. [Downloadable!]
  19. Grandmont, Jean-Michel & Younes, Yves, 1973. "On the Efficiency of a Monetary Equilibrium," Review of Economic Studies, Blackwell Publishing, vol. 40(2), pages 149-65, April. [Downloadable!] (restricted)
  20. Robert E. Lucas, Jr. & Nancy L. Stokey, 1987. "Money and Interest in a Cash-in-Advance Economy," NBER Working Papers 1618, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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