Systemic Risk, Interbank Market Contagion, and the Lender of Last Resort Function

Research output: Chapter in Book/Report/Conference proceedingConference contribution

Abstract

We develop a theoretical model examining the financial stability policy of a centralbank serving as both the lender of last resort and the regulator of the financialsystem. Our model accommodates the possibility of financial contagion through in-terbank market linkages, and adverse feedback from the financial system to the real economy. We identify the volume of activity in the interbank money market, therelative riskiness of the agents in the financial system, and the probability of sys-temic distress as the key factors infuencing the design of financial stability policy.Furthermore, results of simulating the model indicate that there is a substitutioneffect between reducing the expected scope of a central bank's assistance to an in-stitution in distress and increasing bank capital requirements.

Bibliographical metadata

Original languageEnglish
Title of host publication• BIS Irving Fisher Committee Workshop on "Combining micro and macro statistical data for the financial stability analysis", co-organised with the Central Bank of Poland in Warsaw, (December 2015) •F.E.B.S. annual conference, Malaga, Spain (June 2016). • Money, Macro and Finance Group, 48th annual conference, Bath, UK (Sept. 2016). • Southern Finance Association annual conference, San Destin, Florida, USA (November 2016), accepted
ISBN (Electronic)978-92-9197-479-5
Publication statusPublished - 2016