2007/09/04 by Sandro Brusco, Fabio Castiglionesi · 1 citation
Economics, Econometrics and Finance · #Banking stability, regulation, efficiency #Economic theories and models #Global Financial Crisis and Policies #Moral hazard #Market liquidity #Financial contagion #Bankruptcy #Liquidity crisis #Systemic risk #Monetary economics #Liquidity risk #Economics #Capital (architecture) #Business #Financial market #Funding liquidity #Capital market #Financial crisis #Financial system #Finance #Microeconomics #Macroeconomics
paper · doi:10.1111/j.1540-6261.2007.01275.x
openalex publication_date 2007/09/04 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/22
ABSTRACT We study the propagation of financial crises among regions in which banks are protected by limited liability and may take excessive risk. The regions are affected by negatively correlated liquidity shocks, so liquidity coinsurance is Pareto improving. The moral hazard problem can be solved if banks are sufficiently capitalized. Under autarky a limited amount of capital is sufficient to prevent risk‐taking, but when financial markets are open capital becomes insufficient. Thus, bankruptcy occurs with positive probability and the crisis spreads to other regions via financial linkages. Opening financial markets is nevertheless Pareto improving; consumers benefit from liquidity coinsurance, although they pay the cost of excessive risk‐taking.