TY - JOUR
T1 - Financial Innovation, Macroeconomic Stability and Systemic Crisis
AU - Gai, Prasanna
AU - Kapadia, Sujit
AU - Millard, Stephen
AU - Perez, Ander
PY - 2008
Y1 - 2008
N2 - We present a general equilibrium model of intermediation designed to capture some of the key features of the modern financial system. The model incorporates financial constraints and state-contingent contracts, and contains a clearly defined pecuniary externality associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, this externality is capable of generating a systemic financial crisis that may be self-fulfilling. Our model suggests that financial innovation and greater macroeconomic stability may have made financial crises in developed countries less likely than in the past but potentially more severe.
AB - We present a general equilibrium model of intermediation designed to capture some of the key features of the modern financial system. The model incorporates financial constraints and state-contingent contracts, and contains a clearly defined pecuniary externality associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, this externality is capable of generating a systemic financial crisis that may be self-fulfilling. Our model suggests that financial innovation and greater macroeconomic stability may have made financial crises in developed countries less likely than in the past but potentially more severe.
U2 - 10.1111/j.1468-0297.2007.02127.x
DO - 10.1111/j.1468-0297.2007.02127.x
M3 - Article
VL - 118
SP - 401
EP - 426
JO - The Economic Journal
JF - The Economic Journal
IS - 527
ER -