Agostino Capponi from Columbia University.
Paper: Bail-Ins and Bail-Outs: Incentives, Connectivity, and Systemic Stability
We develop a framework to analyze the stability of an interbank network, in which subsidized bail-ins or public bailouts can be coordinated to stop financial contagion. Banks are willing to contribute to a subsidized bail-in only if the social planner?s threat to not bail out insolvent banks is credible. We show that the credibility of the threat exhibits a phase transition: for small shocks, the threat is more credible in a more densely connected network, whereas for large shocks, the threat is more credible in sparsely connected networks. The optimal bail-in plan requires lower taxpayer contributions in more sparsely connected networks. This raises social welfare and makes a sparsely connected network socially preferable over a more densely connected network, even if the densely connected network is more stable in the absence of intervention. (Joint work with Benjamin Bernard and Joseph Stiglitz)