Title page
Content
ABSTRACT 2
1. INTRODUCTION 3
1.1. Related literature 7
1.2. Motivating empirical evidence 9
2. MODEL 10
2.1. Household 10
2.2. Investment projects and aggregate risk 11
2.3. Market for physical capital 12
2.4. Financial markets 13
2.5. Banks 14
2.6. Banks' optimizing behavior 16
2.7. Privately optimal interbank financial contracts 19
2.8. Investment at date 1 20
2.9. Government's problem 21
3. GENERAL EQUILIBRIUM 24
3.1. Bank best response functions at date 0 25
3.2. Subgame perfect Nash equilibria 26
3.3. Welfare-ranking the equilibria 28
4. TWO BENCHMARK ECONOMIES 29
5. SOCIAL PLANNER'S PROBLEM 30
5.1. Social planner's solution 30
5.2. Constrained inefficient risk sharing 31
5.3. Over-borrowing and excessive risk-taking 33
6. OPTIMAL MACROPRUDENTIAL POLICY 33
6.1. Regulation of the interbank market 33
6.2. Regulation of risk taking and aggregate leverage 35
6.3. Practical considerations 35
7. CONCLUSION 35
REFERENCES 37
APPENDICES 40
APPENDIX 1. Household optimization problem 40
APPENDIX 2. Contracting environment between the household and banks 41
APPENDIX 3. Bank optimization problems 42
APPENDIX 4. Optimal household contract 44
APPENDIX 5. Proof of Proposition 3 45
APPENDIX 6. Aggregate investment at date 1 45
APPENDIX 7. Proof of Proposition 4 46
APPENDIX 8. Deriving the government's optimal bailout policy 47
APPENDIX 9. Discussion of government problem 50
APPENDIX 10. Proof of Lemma 1 52
APPENDIX 11. Full planner problem 54
APPENDIX 12. Proof of Proposition 1 57
APPENDIX 13. Benchmark 2: Comparative static on degree of risk aversion 58
Figure 1. Model Environment 10