Type: Working Paper
Government guarantees and financial stability
Working Paper, CEPR Discussion Paper, 2015/10560
ALLEN, Franklin, CARLETTI, Elena, GOLDSTEIN, Itay, LEONELLO, Agnese, Government guarantees and financial stability, CEPR Discussion Paper, 2015/10560 - https://hdl.handle.net/1814/38285
Retrieved from Cadmus, EUI Research Repository
Government guarantees to financial institutions are intended to reduce the likelihood of runs and bank failures, but are also usually associated with distortions in banks’ risk taking decisions. We build a model to analyze these trade-offs based on the global-games literature and its application to bank runs. We derive several results, some of which against common wisdom. First, guarantees reduce the probability of a run, taking as given the amount of bank risk taking, but lead banks to take more risk, which in turn might lead to an increase in the probability of a run. Second, guarantees against fundamental-based failures and panic-based runs may lead to more efficiency than guarantees against panic-based runs alone. Finally, there are cases where following the introduction of guarantees banks take less risk than would be optimal.
Cadmus permanent link: https://hdl.handle.net/1814/38285
Series/Number: CEPR Discussion Paper; 2015/10560
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