Document de travail

Liquidity, Contagion and Financial Crisis

Alexander Guembel et Oren Sussman


We develop a theoretical model where a redistribution of bank capital (e.g., due to reckless trading and/or faulty risk management) leads to a “freeze” of the interbank market. The fire-sale market plays a central role in spreading the crisis to the real economy. In crisis, credit rationing and liquidity hoarding appear simultaneously; endogenous levels of collateral (or margin requirements) are affected by both low fire-sale prices and high lending rates. Relative to previous analysis, this dual channel generates a stronger price and output effect. The main focus is on the policy analysis. We show that i) non-discriminating equity injections are more effective than liquidity injections, but in both the welfare effect is an order-of-magnitude lower than the price effect; ii) a discriminating policy that bails out only distressed banks is feasible but will be limited by incentive-compatibility constraints; iii) a restriction on international capital flows has an ambiguous effect on welfare.


Debt deflation; Bailout; Liquidity Injection;

Codes JEL

  • G21: Banks • Depository Institutions • Micro Finance Institutions • Mortgages
  • G28: Government Policy and Regulation
  • G33: Bankruptcy • Liquidation


Alexander Guembel et Oren Sussman, « Liquidity, Contagion and Financial Crisis », TSE Working Paper, n° 10-240, 25 juin 2010.

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Publié dans

TSE Working Paper, n° 10-240, 25 juin 2010