We study liquidity transfers between banks through the interbank borrowing and asset sale markets when (i) surplus banks providing liquidity have market power, (ii) there are frictions in the lending market due to moral hazard, and (iii) assets are bank-specific. We show that when the outside...

We model a loop between sovereign and bank credit risk. A distressed financial sector induces government bailouts, whose cost leads to increased sovereign credit risk. Increased sovereign credit risk in turn weakens the financial sector by eroding the value of its government debt guarantees and...

Two aspects of systemic risk, the risk that banks fail together, are modeled and their interaction examined: First, the ex-post aspect, in which the failure of a bank brings down a surviving bank as well, and second, the ex-ante aspect, in which banks endogenously hold correlated portfolios...

We examine the regulatory design problem of a central bank whose objective is to ensure an optimal level of individual as well as systemic risk of bank failure in an economy with possibly heterogeneous banks. We model systemic risk as the endogenously chosen correlation of returns on assets held...

I analyze the joint design of two bank regulatory mechanisms: minimum capital requirements, which are an ex-ante mechanism to prevent bank failures, and closure policy, which is an ex-post mechanism to manage the cost of bank failures. At the heart of the paper is a simple but fundamental point:...

Fire sales that occur during crises beg the question of why sufficient outside capital does not move in quickly to take advantage of fire sales, or in other words, why outside capital is so quot;slow-movingquot;. We propose an answer to this puzzle in the context of an equilibrium model of...

We show that financial sector bailouts and sovereign credit risk are intimately linked. A bailout benefits the economy by ameliorating the under-investment problem of the financial sector. However, increasing taxation of the non-financial sector to fund the bailout may be inefficient since it...

What is the effect of financial crises and their resolution on banks' choice of liquid asset holdings? When risky assets have limited pledgeability and banks have relative expertise in employing risky assets, the market for these assets clears only at fire-sale prices following a large number of...

Systemic risk is modeled as the endogenously chosen correlation of returns on assets held by banks. The limited liability of banks and the presence of a negative externality of one bank’s failure on the health of other banks give rise to a systemic risk-shifting incentive where all banks...

Fire sales that occur during crises beg the question of why sufficient outside capital does not move in quickly to take advantage of fire sales, or in other words, why outside capital is so slow-moving. We propose an answer to this puzzle in the context of an equilibrium model of capital...