channel, one bank's capital policy affects the equity value and risk of default of other banks. In a model where such …

risk in which all banks choose inefficiently high leverage to fund correlated assets and market discipline is compromised … ; systemic risk ; bailout ; forbearance ; moral hazard ; capital requirements …

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced … against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures …, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which …

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced … against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures …, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which …

We address the paradox that financial innovations aimed at risk-sharing appear to have made the world riskier … liquid assets. When risk-sharing is primitive, agents selfhedge and hold more liquid assets; this buffers aggregate risks …, resulting in few correlated failures compared to when there is greater risk sharing. We apply this insight to build a model of a …

substitute between saving cash for financial hedging to mitigate financial default risk, and spending on operational hedging to … mitigate operational default risk. Whereas financial hedging increases in financial leverage, operational hedging declines in … credit risk, which is stronger for firms facing financing constraints. We present empirical evidence supporting the …