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Towards a Measure of Financial Fragility

Oriol Aspachs
Financial Markets Group, London School of Economics

Charles A.E. Goodhart
Financial Markets Group, London School of Economics

Dimitrios P. Tsomocos
St Edmund Hall and Said Business School, University of Oxford,
and Bank of England

Lea Zicchino
Bank of England



This paper proposes a measure of financial fragility that is based on economic welfare in a general equilbrium model calibrated against UK data. The model comprises a household sector, three active heterogeneous banks, a central bank/regulator, incomplete markets, and endogenous default. We address the impact of monetary and regulatory policy, credit and capital shocks in the real and financial sectors and how the response of the economy to shocks relates to our measure of financial fragility. Finally we use panel VAR techniques to investigate the relationships between the factors that characterise financial fragility in our model, i.e. banks' probabilities of default and banks' profits - to a proxy of welfare.

Keywords: Financial fragility, Financial contagion, Systemic risk, Banks, Regulatory policy, Monetary policy, Equilibrium analysis.

JEL classification: C33, C68, E4, E5, G11, G21.

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