Liquidity Coinsurance , Moral Hazard and Financial Contagion ∗

@inproceedings{Brusco2005LiquidityC,
  title={Liquidity Coinsurance , Moral Hazard and Financial Contagion ∗},
  author={Sandro Brusco and Fabio Castiglionesi},
  year={2005}
}
We study the propagation of financial crises between regions characterized by moral hazard problems. The source of the problem is that banks are protected by limited liability and may engage in excessive risk taking. The regions are affected by negatively correlated liquidity shocks, so that liquidity coinsurance is Pareto improving. The moral hazard problem can be solved if banks are sufficiently capitalized. Under autarky, a limited investment is needed to achieve optimality, so that a… CONTINUE READING
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