A Model to Analyse Financial Fragility

Goodhart, Charles, Sunirand, Pojanart and Tsomocos, Dimitrios (2006) A Model to Analyse Financial Fragility. Economic Theory, 27 (1). pp. 107-142.

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 nonneutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability and economic
efficiency.

Item Type: Article
Keywords: Financial fragility; Commerical banks; General equilibrium; Default; Incomplete markets; Monetary policy; Regulatory policy; finance
Subject(s): Finance
Date Deposited: 11 Feb 2012 18:02
Last Modified: 18 Sep 2018 13:09
Funders: N/A
URI: http://eureka.sbs.ox.ac.uk/id/eprint/1860

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