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Economic Theory

, Volume 32, Issue 2, pp 381–398 | Cite as

Banks, relative performance, and sequential contagion

  • Dimitrios P. Tsomocos
  • Sudipto Bhattacharya
  • Charles A. E. Goodhart
  • Pojanart Sunirand
Research Article

Abstract

We develop a multi-period general equilibrium model of bank deposit, credit, and interim inter-bank loan markets in which banks initially specialize in their choices of debtors, leading to under-diversification, but nevertheless become entwined via inter-bank markets, leading to the fortunes of one bank affecting the profits and default rates of the other in a sequential manner. Lack of (full) diversification among credit risks arises in our model owing to a relative profit argument in each banker’s utility function, which is otherwise risk- and default-averse. We examine its implications for the welfare of depositors and debtors.

Keywords

Relative performance Sequential contagion Banks 

JEL Classification Numbers

C33 C68 E4 

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Copyright information

© Springer-Verlag 2007

Authors and Affiliations

  • Dimitrios P. Tsomocos
    • 2
    • 3
  • Sudipto Bhattacharya
    • 1
  • Charles A. E. Goodhart
    • 2
  • Pojanart Sunirand
    • 2
  1. 1.London School of Economics and CEPRLondonUK
  2. 2.Financial Markets GroupLondon School of EconomicsLondonUK
  3. 3.Saïd Business School and St. Edmund HallUniversity of OxfordOxfordUK

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