bank activity has on interbank markets. In our model, banks optimize a portfolio of risky investments and riskless excess … household deposits. We then introduce a central bank into the model and show that central bank activity enhances financial … stability. We model the default of a large bank and analyse the resulting contagion effects. This is compared to a common shock …

multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and … firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate … detrimental effects of higher risk taking incentives.We find that central bank supply of liquidity quite generally increases …