Liquidity Coinsurance, Moral Hazard, and Financial Contagion

A speed control device used in an image forming apparatus which includes a detector for checking whether the backing of an image receiving sheet is made of ordinary paper or OHP film, and is capable of controlling the rotating speeds of the motors depending upon the type of the image receivingsheet, thereby ensuring that the thermoplastic resin is molten to achieve optimum fluidity.

Abstract

ABSTRACT We study the propagation of financial crises among regions in which banks are protected by limited liability and may take excessive risk. The regions are affected by negatively correlated liquidity shocks, so liquidity coinsurance is Pareto improving. The moral hazard problem can be solved if banks are sufficiently capitalized. Under autarky a limited amount of capital is sufficient to prevent risk‐taking, but when financial markets are open capital becomes insufficient. Thus, bankruptcy occurs with positive probability and the crisis spreads to other regions via financial linkages. Opening financial markets is nevertheless Pareto improving; consumers benefit from liquidity coinsurance, although they pay the cost of excessive risk‐taking.