OXFORD 2007

1. History and institutions 1
1.1 Introduction 1
1.2 Historical crises in Europe and the US 2
1.3 Crises and stock market crashes 5
1.4 Currency and twin crises 9
1.5 Crises in different eras 10
1.6 Some recent crises 14
1.6.1 The Scandinavian crises 14
1.6.2 Japan 15
1.6.3 The Asian crisis 15
1.6.4 The Russian crisis and long term capital
management (LTCM) 16
1.6.5 The Argentina crisis of 2001–2002 17
1.7 The costs of crises 18
1.8 Theories of crises 19
1.9 Concluding remarks 23
2. Time, uncertainty, and liquidity 27
2.1 Efficient allocation over time 27
2.1.1 Consumption and saving 27
2.1.2 Production 36
2.2 Uncertainty 40
2.2.1 Contingent commodities and risk sharing 40
2.2.2 Attitudes toward risk 44
2.2.3 Insurance and risk pooling 48
2.2.4 Portfolio choice 49
2.3 Liquidity 52
2.4 Concluding remarks 57
3. Intermediation and crises 58
3.1 The liquidity problem 59
3.2 Market equilibrium 60
3.3 The efficient solution 64
3.4 The banking solution 72
3.5 Bank runs 74

3.6 Equilibrium bank runs 76
3.7 The business cycle view of bank runs 82
3.8 The global games approach to finding a unique
equilibrium 90
3.9 Literature review 94
3.10 Concluding remarks 96
4. Asset markets 99
4.1 Market participation 99
4.2 The model 103
4.3 Equilibrium 104
4.3.1 Market-clearing at date 1 107
4.3.2 Portfolio choice 109
4.4 Cash-in-the-market pricing 110
4.5 Limited participation 114
4.5.1 The model 116
4.5.2 Equilibrium 117
4.5.3 Equilibrium with full participation 120
4.5.4 Full participation and asset-price volatility 120
4.5.5 Limited participation and asset-price volatility 121
4.5.6 Multiple Pareto-ranked equilibria 123
4.6 Summary 124
5. Financial fragility 126
5.1 Markets, banks, and consumers 128
5.2 Types of equilibrium 132
5.2.1 Fundamental equilibrium with no aggregate
uncertainty 133
5.2.2 Aggregate uncertainty 135
5.2.3 Sunspot equilibria 140
5.2.4 Idiosyncratic liquidity shocks for banks 142
5.2.5 Equilibrium without bankruptcy 144
5.2.6 Complete versus incomplete markets 146
5.3 Relation to the literature 147
5.4 Discussion 148
6. Intermediation and markets 153
6.1 Complete markets 155
6.2 Intermediation and markets 164
6.2.1 Efficient risk sharing 165
6.2.2 Equilibrium with complete financial markets 167

6.2.3 An alternative formulation of complete markets 170
6.2.4 The general case 172
6.2.5 Implementing the first best without complete
markets 177
6.3 Incomplete contracts 181
6.3.1 Complete markets and aggregate risk 182
6.3.2 The intermediary’s problem with incomplete
markets 186
6.4 Conclusion 188
7. Optimal regulation 190
7.1 Capital regulation 191
7.1.1 Optimal capital structure 194
7.1.2 Models with aggregate uncertainty 199
7.2 Capital structure with complete markets 201
7.3 Regulating liquidity 204
7.3.1 Comparative statics 206
7.3.2 Too much or too little liquidity? 209
7.4 Literature review 213
7.5 Concluding remarks 213
8. Money and prices 216
8.1 An example 218
8.2 Optimal currency crises 223
8.3 Dollarization and incentives 226
8.4 Literature review 228
8.5 Concluding remarks 232
9. Bubbles and crises 235
9.1 Agency problems and positive bubbles 237
9.1.1 The risk-shifting problem 238
9.1.2 Credit and interest rate determination 243
9.1.3 Financial risk 245
9.1.4 Financial fragility 246
9.2 Banking crises and negative bubbles 247
9.2.1 The model 247
9.2.2 Optimal risk sharing 248
9.2.3 Optimal deposit contracts 251
9.2.4 An asset market 252
9.2.5 Optimal monetary policy 256
9.3 Concluding remarks 258

10. Contagion 260
10.1 Liquidity preference 263
10.2 Optimal risk sharing 266
10.3 Decentralization 268
10.4 Contagion 274
10.4.1 The liquidation “pecking order” 275
10.4.2 Liquidation values 276
10.4.3 Buffers and bank runs 277
10.4.4 Many regions 280
10.5 Robustness 280
10.6 Containment 281
10.7 Discussion 282
10.8 Applications 284
10.8.1 Upper andWorms (2004) 284
10.8.2 Degryse and Nguyen (2004) 290
10.8.3 Cifuentes, Ferrucci, and Shin (2005) 291
10.9 Literature review 293
10.10 Concluding remarks 295
Index 299