Interbank Deposit and Financial Contagion
Date Issued
2012
Date
2012
Author(s)
Wu, Men-Cheng
Abstract
This article continues the model of Allen and Gale (2000) to discuss the relationship between interbank deposits and financial contagion. This paper presents a new perspective to explain the relationship between interbank deposits and financial contagion. First, in the equilibrium model, in the original article of Allen and Gale (2000), they do not detailed discuss the reasons for interbank deposits decision-making process. However, in this paper, we attempt to explain the decision process of interbank deposits by using game theory. We suggest that the value of interbank deposits should be able to exist an optimal choice, not mentioned in their article, the minimum risk-sharing value. In addition, we also show that the interbank deposits in their model are underestimated. The real interbank deposits selection should be greater than the value of choice in their model. Once selecting a new interbank deposits value, the spillover effects of financial contagion will significantly be enlarger than that in their article. Second, in non-equilibrium model, we explore what will the financial system change once a bank having a risk estimation error. In this article, we define the risk estimation error as that the bank overestimated the withdraw probability of early consumers and they deposit excessive interbank deposits at other banks. First, once a bank having a risk estimation error, the bank will be insolvent. However, if the error value is too large, the bank will be bankrupt. Once the bank is bankrupt, these losses will be spread to other cooperative banks through the interbank deposits (spillover effects). When the spillover effect is small, it will only lead other banks to be insolvent; but when the spillover effect is big, it will lead other banks to be bankrupt. In addition, when a bank having a risk estimation error, other banks may have excess deposits to invest the long-term investments and they can earn positive profits. So once a bank having a risk estimation error, other banks will likely earn profits or suffer losses.
Subjects
interbank deposits
financial contagion
risk estimation error
insolvent
bankrupt
Type
thesis
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