***PLEASE NOTE: Change to usual day and venue***
Friday 24 February 2017: Room 32L.G.15 (32 Lincoln's Inn Fields) 12pm to 1pm
Assistant Professor, Industrial Engineering & Operations Research, Columbia University
Title - Bail-ins and bail-outs: incentives, connectivity, and systemic stability
Abstract - We analyze the stability of an interbank network, in which rescues in the form of subsidized bail-ins or public bailouts can be coordinated to stop financial contagion. The coordination of a rescue consortium between a benevolent social planner and the banks is modeled as a sequential game. We show that the equilibrium welfare losses are generically unique, depending heavily on the network structure, which influences whether or not the social planner's threat to not intervene is credible. We provide conditions under which the threat is credible and characterize the optimal intervention plan.
Our analysis shows that sparsely connected networks may enhance financial stability in two ways: (i) a smaller amplification of the shock without intervention may enhance credibility of the social planner's threat and (ii) because default resolution costs are concentrated, the creditors of defaulting banks can be incentivized to make large contributions to a subsidized bail-in. This may make a sparsely connected network socially preferable over a more densely connected network, even if the densely connected network is financially more stable in the absence of any intervention.
Based on joint work with Benjamin Bernard and Joseph Stiglitz