Annals of Finance

, Volume 3, Issue 1, pp 37–74 | Cite as

Towards a measure of financial fragility

  • Oriol Aspachs
  • Charles A. E. Goodhart
  • Dimitrios P. Tsomocos
  • Lea Zicchino
Special Issue


The paper proposes a measure of financial fragility that is based on economic welfare in a general equilibrium model calibrated against UK data. The model comprises a household sector, three active heterogeneous banks, a central bank/regulator, incomplete markets, and endogenous default. We address the impact of monetary and regulatory policy, credit and capital shocks in the real and financial sectors and how the response of the economy to shocks relates to our measure of financial fragility. Finally we use panel VAR techniques to investigate the relationships between the factors that characterise financial fragility in our model, i.e. banks’ probabilities of default and banks’ profits – to a proxy of welfare.


Financial fragility Banks Regulatory policy Monetary policy Equilibrium analysis 

JEL Classification Numbers

C33 C68 E4 E5 G11 G21 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Allen B., Wood G.E. (2006) Defining and achieving financial stability. J Financ Stability 2, 152–172CrossRefGoogle Scholar
  2. Arellano M., Bover O. (1995) Another look at the instrumental variable estimation of error component models. J Econ 68, 29-51Google Scholar
  3. Bank for International Settlements: Implications of Structural Change for the Nature of Systemic Risk. Basel, Switzerland (1998)Google Scholar
  4. Bhattacharya S., Goodhart C.A.E., Sunirand P., Tsomocos D.P. (2003) Relative performance, banks and sequential contagion. University of Oxford, mimeoGoogle Scholar
  5. Caprio G., Klingebiel, D.: Bank Insolvencies: Cross-Country Experience, Policy Research Working Paper No 1620, World Bank (1996)Google Scholar
  6. Caprio G., Klingebiel D. Episodes of Systemic and Borderline Financial Crises, mimeo, World Bank (2003)Google Scholar
  7. Crockett, A.: Maintaining Financial Stability in a Global Economy. In: Federal Reserve Bank of Kansas City’s Symposium, Jackson Hole, Wyoming, 28–30 August 1997Google Scholar
  8. Foot, M.: Protecting Financial Stability – How good are we at it?, speech given at the University of Birmingham, June 6. Available on line at (2003)Google Scholar
  9. Goodhart, C.A.E.: Some new directions for financial stability? Per Jacobsson lecture. Available at (2004)Google Scholar
  10. Goodhart C.A.E., Hofmann B. (2005) The Phillips curve, the IS curve and Monetary transmission: evidence for the US and the Euro Area. CESifo Econ Stud 51, 757–75CrossRefGoogle Scholar
  11. Goodhart, C.A.E., Hofmann, B., Segoviano, M.: Default, Credit Growth, and Asset Prices, mimeo, London School of Economics (2005)Google Scholar
  12. Goodhart, C.A.E., Sunirand, P., Tsomocos, D.P.: A Model to analyse financial fragility: applications. J Financ Stability 1, 1–30 (2004)Google Scholar
  13. Goodhart C.A.E., Sunirand P., Tsomocos D.P. (2005) A risk assessment model for Banks Ann Financ 1, 197–224Google Scholar
  14. Goodhart C.A.E., Sunirand P., Tsomocos D.P. (2006a) A model to analyse financial fragility. Econ Theory 27, 107–142CrossRefGoogle Scholar
  15. Goodhart C.A.E., Sunirand P., Tsomocos D.P. (2006b) A time series analysis of financial fragility in the UK banking system. Ann Financ 2, 1–21CrossRefGoogle Scholar
  16. Goodhart C.A.E., Zicchino L. A model to analyse financial fragility, Bank of England Financial Stability Review, June, pp.106–115 (2005)Google Scholar
  17. Haldane, A., Hall, S., Saporta, V., Tanaka, M.: Financial stability and macroeconomic models, Bank of England Financial Stability Review, pp. 80–88 (2004)Google Scholar
  18. Hellman T.F., Murdock K.C., Stiglitz J.E. (2000) Liberalization, moral hazard in banking, and prudential regulation: are capital requirements enough?. Am Econ Rev 90, 147–165CrossRefGoogle Scholar
  19. Issing, O.: Monetary and financial stability: is there a trade-off? Paper presented at the Conference on Monetary Stability and the Business Cycle, BIS, Basel, 28–29 March 2003Google Scholar
  20. Kaminsky G., Reinhart C. (1999) The twin crises: The causes of banking and balance-of-payments problems. Am. Econ. Rev. 88, 473–500CrossRefGoogle Scholar
  21. Lindgren C.J., Garcia G., Saal M.I. (1996) Bank soundness and macroeconomic policy. International Monetary Fund, Washington D.C.Google Scholar
  22. Love I., Zicchino L. (2006) Financial development and dynamic investment behaviour: evidence from Panel VAR. Q. Rev Econ Financ 46, 190–210CrossRefGoogle Scholar
  23. Minsky, H. P.: The Arestis Skouras (eds.) In: Financial Instability Hypothesis: A Restatement, in Post Keynesian Economic Theory. (1985)Google Scholar
  24. Mishkin F.S. (1994) Global Financial Instability: framework, events, issues. J Econ Perspect 13, 3–25CrossRefGoogle Scholar
  25. Nier E. (2005) Banking stability and transparency. J Financ Stability 1, 342–54CrossRefGoogle Scholar
  26. Repullo R. (2004) Capital requirements, market power, and risk-taking in banking. J Financ Intermed. 13, 156–182CrossRefGoogle Scholar
  27. Repullo R., Suarez J. (2004) Loan pricing under basel capital requirements. J Financ Intermed. 13, 496–521CrossRefGoogle Scholar
  28. Schwartz A. Real and pseudo financial crises. In: Financial Crises and the World Banking System. Capie, F.H., Wood, G.E., (eds.) Macmillan, London (1986)Google Scholar
  29. Shubik M., Wilson C. (1977) The optimal bankruptcy rule in a trading economy using fiat money. J Econ 37, 337–54Google Scholar
  30. Tsomocos D.P. (2003a) Equilibrium analysis, banking and financial instability. J Math Econ 39, 619–655CrossRefGoogle Scholar
  31. Tsomocos D.P. Equilibrium analysis, banking, contagion and financial fragility, Bank of England Working Paper No. 175 (2003b)Google Scholar
  32. Tsomocos D.P., Zicchino L. On modelling endogenous default, financial markets group discussion paper No. 548 (2005)Google Scholar

Copyright information

© Springer-Verlag 2006

Authors and Affiliations

  • Oriol Aspachs
    • 1
  • Charles A. E. Goodhart
    • 1
  • Dimitrios P. Tsomocos
    • 1
    • 2
  • Lea Zicchino
    • 3
  1. 1.London School of Economics, and Financial Markets GroupLondonUK
  2. 2.Said Business School and St. Edmund HallUniversity of OxfordOxfordUK
  3. 3.Bank of EnglandLondonUK

Personalised recommendations