Collective Moral Hazard and the Interbank Market
American Economic Journal: Macroeconomics
vol. 15,
no. 2, April 2023
(pp. 35-64)
Abstract
The concentration of risk within the financial system leads to systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk-taking incentives of financial institutions when the government optimally intervenes during crises. By issuing interbank claims, risky institutions endogenously become large and interconnected. This concentrated structure enables institutions to share the risk of systemic crises in a privately optimal way but leads to excessive risk taking even by peripheral institutions. Interconnectedness and excessive risk taking reinforce one another. Macroprudential regulation that limits the interconnectedness of risky institutions improves welfare.Citation
Altinoglu, Levent, and Joseph E. Stiglitz. 2023. "Collective Moral Hazard and the Interbank Market." American Economic Journal: Macroeconomics, 15 (2): 35-64. DOI: 10.1257/mac.20210333Additional Materials
JEL Classification
- D82 Asymmetric and Private Information; Mechanism Design
- E44 Financial Markets and the Macroeconomy
- G01 Financial Crises
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G28 Financial Institutions and Services: Government Policy and Regulation
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