Understanding Financial Crises
What causes a financial crisis? Can financial crises be anticipated or even avoided? What can be done to lessen their impact? Should governments and international institutions intervene? Or should financial crises be left to run their course? In the aftermath of the Asian financial crisis, many blamed international institutions, corruption, governments, and flawed macro and microeconomic policies not only for causing the crisis but also unnecessarily lengthening and deepening it. Based on ten years of research, the authors develop a theoretical approach to analyzing financial crises. Beginning with a review of the history of financial crises and providing readers with the basic economic tools needed to understand the literature, the authors construct a series of increasingly sophisticated models. Throughout, the authors guide the reader through the existing theoretical and empirical literature while also building on their own theoretical approach. The text presents the modern theory of intermediation, introduces asset markets and the causes of asset price volatility, and discusses the interaction of banks and markets. The book also deals with more specialized topics, including optimal financial regulation, bubbles, and financial contagion.
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aggregate uncertainty Allen and Gale amount Arrow securities asset at date asset market asset prices assume bank runs bank’s banking crises banking panics banking system borrow bubble capital structure central bank chapter choose complete markets consumer’s consumption allocation consumption at date consumption stream contagion contingent commodities cost crisis currency crises default demand for liquidity denote deposit contract depositors early consumers Economic effect efficient example exchange rate expected utility feasible Figure financial crises financial system first-order condition fraction of early future consumption hold incentive constraint income incomplete increase interbank intermediary investors large number late consumers liquidity preference liquidity shocks long asset marginal utility market clearing maximize occurs participation planner portfolio present value price volatility probability problem proportion of early regulation relative risk aversion risk aversion risk sharing risky asset safe asset satisfy short asset sunspot sunspot equilibrium Suppose units of consumption withdraw at date