Abstract
This paper introduces a theoretical model to analyze the optimal bailout policy in an interconnected banking system. The model intends to highlight two motivations behind providing a partial bailout to banks in distress: prevention of costly bankruptcies and prevention of financial contagion. In the extreme cases where the cost of bailout is sufficiently high or low, the zero-bailout policy or the full-bailout policy is optimal respectively. Otherwise, a partial bailout policy is optimal. The fiscal authority has to balance the benefits of bailouts from bankruptcy and contagion prevention against the cost when it decides on the amount of partial bailout to provide to banks.
Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
