Optimal Bailouts and the Doom Loop with a Financial Network / Agostino Capponi, Felix C. Corell, Joseph E. Stiglitz.

Format:

Book

Author/Creator:

Capponi, Agostino.

Contributor:

National Bureau of Economic Research.

Corell, Felix C.

Stiglitz, Joseph E.

Series:

Working Paper Series (National Bureau of Economic Research) no. w27074.

NBER working paper series no. w27074

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2020.

Summary:

Banks usually hold large amounts of domestic debt which makes them vulnerable to their own sovereign's default risk. At the same time, governments often resort to costly bailouts when their banking sector is in trouble. We investigate how the network structure and the distribution of ownership of sovereign debt within the banking sector jointly affect the optimal bailout policy under this "doom loop". We argue that rescuing banks with high domestic sovereign exposure is optimal if these banks are sufficiently central, even though that requires larger bailout expenditures than rescuing otherwise identical low-exposure banks. Our model illustrates how the "doom loop" exacerbates the "too interconnected to fail" problem.

Notes:

Print version record

May 2020.