We develop a theoretical model where a redistribution of bank capital (e.g., due to reckless trading and/or faulty risk management) leads to a "freeze" of the interbank market. The fire-sale market plays a central role in spreading the crisis to the real economy. In crisis, credit rationing and...

We develop a theory of sovereign borrowing where default penalties are not implementable. We show that when debt is held by both domestic and foreign agents, the median voter might have an interest in serving it. Our theory has important practical implications regarding a) the role of financial...

Motivated by the observation that exchange-rate management resembles market making, we use microstructure theory in order to conduct a welfare analysis of exchange-rate management, including the quot;corner solutionsquot; of a free float and a fixed peg. We show that a policy that smoothes out...

This paper studies how a banking supervisor should design a bank stress test. The test directly provides public information about a bank's stress resilience, which is a noisy indicator of the bank's true capitalization level. Moreover, the test result affects incentives for information...

We analyze information production incentives for traders in financial markets, when firms condition investment decisions on information revealed through stock prices. We show that traders' private value of information about a firm's investment project increases with the ex ante likelihood the...