Financial Fragility and Interbank Structure

Abstract

This paper follows Allen and Gale (2000) to model financial contagion as an equilibrium phenomenon. I assume a two-country economy where banks in each country hold interregional claims on other banks to provide insurance against liquidity preference shocks. The results completely replicate Allen-Gale model. To further test the relative robustness of different market structures I test the implication of moral hazard as in Brusco and Castiglionesi (2007). I find that under certain situation, complete and incomplete structures are equally fragile.