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Banks, relative performance, and sequential contagion

By Dimitrios P. Tsomocos, Sudipto Bhattacharya, Charles A. E. Goodhart and Pojanart Sunirand

Abstract

We develop a multi-period general equilibrium model of bank deposit, credit, and interim inter-bank loan markets in which banks initially specialize in their choices of debtors, leading to under-diversification, but nevertheless become entwined via inter-bank markets, leading to the fortunes of one bank affecting the profits and default rates of the other in a sequential manner. Lack of (full) diversification among credit risks arises in our model owing to a relative profit argument in each banker’s utility function, which is otherwise risk- and default-averse. We examine its implications for the welfare of depositors and debtors

Topics: HB Economic Theory, HF Commerce, HG Finance
Publisher: Springer
Year: 2007
DOI identifier: 10.1007/s00199-006-0190-7
OAI identifier: oai:eprints.lse.ac.uk:39708
Provided by: LSE Research Online
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