The financial meltdown: a model with endogenous default probability

Ferrari, Massimo (2014): The financial meltdown: a model with endogenous default probability.

Abstract

Abstract Starting from some of the most recent literature developed after the world financial crisis, it has been developed a model with heterogeneous agents and an active interbank market, characterized by an endogenous default probability. The key feature of the analysis is that the probability of default evolves endogenously and is taken into account by banks in their investment decisions. In each period banks, that are heterogeneous, decide to invest only a part, or even none, of their surplus funds on loans to other financial institutions, if the probability of default is high enough, preferring to use that funds to purchase riskless assets. This decision effects the total supply of credit to firms and, through it, the total level of investments, output and employment.

Abstract When a financial crisis occurs, banks reduce their supply of interbank funds replicating, to some extent, the behaviour of the interbank market during the last crisis. Through the definition of an endogenous default probability and the analysis of how it effects the credit supply, it is possible to understand the connections between the behaviour of financial markets and the real economy. The model, at last, is calibrated in order to test the response of the system to exogenous shocks and to conventional and unconventional economic policies.

• Item Type: MPRA Paper
• Language: English
• Keywords: macroeconomics, macrofinance, endogenous default, crisis, default, policies, DSGE, heterogeneous agents
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; G - Financial Economics > G0 - General > G01 - Financial Crises; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

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