van der Kwaak, C.G.F.; van Wijnbergen, S.J.G. - In: Journal of Economic Dynamics and Control 43 (2014) C, pp. 218-240
We show that with intertwined weak banks and weak sovereigns, bank recapitalizations become much less effective. We construct a DSGE model with leverage constrained banks lending to firms and holding domestic government bonds. Bond prices reflect endogenously generated sovereign risk. This...