Financial Contagion
2000/02/01 by Franklin Allen, Douglas Gale · 3,187 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Aggregate (composite) #Banking stability, regulation, efficiency #Corporate Finance and Governance #Economics #Financial contagion #Financial crisis #Global Financial Crisis and Policies #Liquidity preference #Macroeconomics #Market liquidity #Microeconomics #Monetary economics #Preference #Shock (circulatory)
paper · doi:10.1086/262109
published in Journal of Political Economy 108(1), 1-33 (University of Chicago Press)
openalex publication_date 2000/02/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/05
Abstract
Financial contagion is modeled as an equilibrium phenomenon. Because liquidity preference shocks are imperfectly correlated across regions, banks hold interregional claims on other banks to provide insurance against liquidity preference shocks. When there is no aggregate uncertainty, the first‐best allocation of risk sharing can be achieved. However, this arrangement is financially fragile. A small liquidity preference shock in one region can spread by contagion throughout the economy. The possibility of contagion depends strongly on the completeness of the structure of interregional claims. Complete claims structures are shown to be more robust than incomplete structures.
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