Online from: 1988
|Title:||Collective risk management in a flight to quality episode|
|Author(s):||Caballero R J, Krishnamurthy A|
|Journal:||Journal of Finance, Oct 2008, Volume: 63 Issue: 5 pp.2195-2230 (36 pages)|
|Keywords:||Central Banks, Credit, Liquidity, Loans, Uncertainty, Usa|
|Article type:||Conceptual paper|
|Reference:||38AA758 (Permanent URL)|
Design/methodology/approach - Describes financial crises typified by a flight to quality, and models liquidity shortages with Knight's (1921) uncertainty. Analyses its equilibrium with agent decision making and a credit crunch.
Findings - Finds that a flight to quality occurs in a financial crisis and the central bank intervenes with liquidity to overcome conservatism, as a last resort policy to avoid moral hazard risks.
Research limitations/implications - Implies that this model can explain how crises were avoided, and that a liquidation model would be inadequate. Suggests applying to the credit derivatives market and financial innovations.
Practical implications - Argues strongly that the central bank should be a lender of last resort to overcome Knightian uncertainty.
Originality/value - Presents a model that could have been applied to the subprime crisis, but in the event was overtaken by more extreme events.