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Game-Theoretic Modeling of Banking Crises

Student: Kurochkina Marina

Supervisor: Sylvain Carré

Faculty: International College of Economics and Finance

Educational Programme: Financial Economics (Master)

Year of Graduation: 2021

Despite the fact that many countries have already learned how to deal with debt crises, banking crises are still a problem. One of the main questions in the economic literature remains the question of what determines banking crises and what to do. The old approaches are interesting, but they do not give a complete understanding of which policy to choose, especially in cases when agents behave irrationally, relying on expectations about other agents’ actions. The global games approach allows to find the unique equilibrium that depends only on the initial state of the economy. However, only few works include the central bank in the global games setting, and many of them have some limitations. That is why the current paper aims to study the impact of central bank assistance on the optimal choice of the bank and probability of the crisis in the framework of a unique equilibrium. The anticipated help from the central bank can reduce incentives for consumers to withdraw funds from the bank but increase the bank's incentives to accumulate more risks (more leverage). It can worsen the situation and even increase the likelihood of a crisis. Introduction of leverage regulation in addition can solve this problem.

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