This paper presents preliminary ndings and is being distributed to economists

and other interested readers solely to stimulate discussion and elicit comments.
The views expressed in this paper are those of the authors and are not necessarily
reective of views at the Federal Reserve Bank of New York or the Federal
Reserve System. Any errors or omissions are the responsibility of the authors.
Federal Reserve Bank of New York
Staff Reports
Staff Report No. 599
February 2013
Marco Cipriani
Antoine Martin
Bruno M. Parigi
Money Market Funds Intermediation,
Bank Instability, and Contagion
REPORTS
FRBNY
Staff
Cipriani, Martin: Federal Reserve Bank of New York (e-mail: marco.cipriani@ny.frb.org,
antoine.martin@ny.frb.org). Parigi: University of Padova (brunomaria.parigi@unipd.it). The
authors gratefully acknowledge hospitality from the European University Institute, where part
of this paper was written, and also thank Jamie McAndrews, Todd Keister, Enrico Perotti, and
seminar audiences at the Netherlands Central Bank and the Bank of France for useful comments.
The views expressed in this paper are those of the authors and do not necessarily reect the
position of the Federal Reserve Bank of New York or the Federal Reserve System.
Abstract
In recent years, U.S. banks have increasingly relied on deposits from nancial intermedi-
aries, especially money market funds (MMFs), which collect funds from large institu-
tional investors and lend them to banks. In this paper, we show that intermediation
through MMFs allows investors to limit their exposure to a given bank (i.e., reap gains
from diversication). However, since MMFs are themselves subject to runs from their
own investors, a banking system intermediated through MMFs is more unstable than one
in which investors interact directly with banks. A mechanism through which instability
can arise in an MMF-intermediated nancial system is the release of private information
on bank assets, which is aggregated by MMFs and could lead them to withdraw en masse
from a bank. In addition, we show that MMF intermediation can also be a channel of
contagion among banking institutions.
Key words: Money market funds, bank runs
Money Market Funds Intermediation, Bank Instability, and Contagion
Marco Cipriani, Antoine Martin, and Bruno M. Parigi
Federal Reserve Bank of New York Staff Reports, no. 599
February 2013
JEL classication: G01, G21, G23
1 IntroductIon
In ioconl yoais, laigo gloLal Lanks havo incioasingly iolioo on ooposils
fiom lnancial inloimooiaiios, ospocially monoy maikol funos (MMFs).
MMFs collocl funos fiom inslilulional ano wholosalo invoslois ano lono
lhom lo Lanks.
Lank ooposils of inslilulional ano wholosalo invoslois aio nol fully
covoioo Ly ooposil insuianco. As a iosull, lhoy nooo lo limil lhoii ox-
posuio lo a singlo Lanking inslilulion ano oivoisify lhoii poilfolio of
ooposils. Inloimooialion Ly inslilulions such as MMFs allows laigo in-
voslois lo ioap gains fiomoivoisilcalion, whilo saving on Lank-moniloiing
cosls.
In lho U.S., MMFs havo Locomo a voiy populai lnancial insliumonl,
compiising 21 poiconl of all mulual funo assols. 1hoii assols unooi
managomonl giow fiom appioximaloly $2 liillion in 200 lo $8 liillion
al lho ono of 2008 ano conliacloo only miloly ouiing lho lnancial ciisis
(lo $2.6 liillion in 2012).
1
MMFs aio koy piovioois of shoil-loimfunoing,
ospocially lo lho lnancial socloi. As 1aLlo 1 shows, in 2012 lhoy woio
among lho laigosl invoslois in somo assol classos, lnancing 48 poiconl
of lnancial commoicial papoi ano 20 poiconl of coililcalos of ooposil.
1aLlo 1: MMF Invoslmonls Ly Assol Classos
Nonlnancial
CI
Financial
CI
Assol-
Lackoo
commoi-
cial papoi
(ALCI)
Coililcalos
of Doposil
Iopuichaso
Agioo-
monls
48/ 48/ 88/ 20/ 88/
7Ln 207Ln 117Ln 484Ln 01Ln
As a poiconlago of oulslanoing assols. Juno 2012. Souico: McCaLo ol al. (2012).
In lho U.S., MMFs oloi oomanoaLlo ooposils (shaios) ioooomaLlo
al pai, lhal is, wilh lxoo nol assol valuo (NAV). Whon lho NAV (i.o.,
lho valuo of lho assol poi shaio) falls Lolow $0.00 ('Lioaks lho Luck'),
lho MMF is foicoo Ly SLC iogulalion lo io-piico all ils shaios. Honco
ovon small lossos can slail a iun sinco invoslois havo an inconlivo lo
ioooom lhoii shaios Lofoio lho MMF Lioaks lho Luck. In SoplomLoi
2008, lho Iosoivo Iiimaiy Funo Lioko lho Luck, causing a slampooo of
wilhoiawals acioss lho socloi. 1o slom lho panic, lho Foooial Iosoivo
pioviooo a laigo amounl of liquioily lhiough omoigoncy facililios ano
lho 1ioasuiy Dopailmonl guaianlooo MMF assols.
1
Foi a oosciiplion of lho MMF inousliy, soo McCaLo ol al. (2012).
1
A Lanking syslom inloimooialoo lhiough MMFs can Lo moio un-
slaLlo lhan ono in which invoslois inloiacl oiioclly wilh Lanks. Sinco
MMFs aio lhomsolvos suLjocl lo iun-liko iooomplions fiom lhoii own
invoslois, lhoy may ioacl lo lhom Ly iunning lho Lanks in which lhoy
havo ooposiloo, honco amplifying lho impacl of lho inilial iooomplions.
1ho inslaLilily of a lnancial syslom in which Lanks lnanco lhomsolvos
lhiough inloimooiaiios such as MMFs was ono of lho oiiving foicos Lo-
hino lho ioconl iofoim oloil of lho MMF inousliy Ly lho SLC ano lho
FSOC.
2
In lhis papoi, wo sluoy an oconomy a la Diamono ano DyLvig (1088)
(DD hoioafloi) wilh lwo Lanks, whoso long-loim invoslmonls havo slo-
chaslic ano (poifoclly) nogalivoly coiiolaloo ioluins. Doposiling in lho
lwo Lanks allows agonls lo ioouco lhoii iisk lhiough oivoisilcalion. Wo
consiooi lwo maikol sliucluios: oiiocl lnanco, whoio invoslois ooposil
oiioclly inlo lho Lanks, ano MMF inloimooialion, whoio lho iolalionship
Lolwoon invoslois ano Lanks is inloimooialoo lhiough MMFs.
8
In lho moool, Lank Lankiuplcy aiisos whon a fiaclion of invoslois
unoxpoclooly wilhoiaw lhoii funos oilhoi fiom a Lank oi fiom an MMF.
Invoslois wilhoiaw oilhoi Locauso lhoy iocoivo a liquioily shock, oi Lo-
causo lhoy iocoivo a poifoclly infoimalivo (nogalivo) signal on lho ioluin
of lho invoslmonl of ono of lho lwo Lanks.
Unooi oiiocl lnanco, unoxpocloo wilhoiawals causo Lank Lankiuplcy
only if lho amounl wilhoiawn is laigo onough lo foico lho Lank inlo liq-
uioalion. In conliasl, wilh MMF inloimooialion, whon a fiaclion of
invoslois unoxpoclooly ioooom fiom lho MMF, lhoii aclions iopiosonl a
(noisy) signal on lho slalo of lho woilo foi lho MMF. If lhis signal is
sliong onough, lho MMF will iun lho Lank, wilhoiawing all ils funos
ano causing Lankiuplcy ovon if lho fiaclion of lho unoxpocloo iooomp-
lions was small onough lhal Lankiuplcy woulo nol havo occuiioo unooi
oiiocl lnanco. 1ho inslaLilily of MMF inloimooialion sloms fiom lho
facl lhal lho nogalivo infoimalion conlonl of an unoxpocloo iooomplion
fiom an inloimooiaiy such as an MMF amplilos lho olocl of lho io-
oomplions lhomsolvos. Locauso of lhis, an oconomy inloimooialoo Ly
MMFs is gonoiically moio unslaLlo lhan a oiiocl-lnanco sliucluio.
1ho amplilcalion mochanism is possiLlo givon lhal MMFs aio suL-
jocl lo iun-liko iooomplions Locauso lhoy oloi invoslois oomanoaLlo
liaLililios in oiooi lo salisfy lhoii liquioily nooos. Whon an MMF oxpo-
2
Soo, foi inslanco, Duoloy (2012) ano Goilhnoi (2012).
8
MMFs lono lo Lanks moslly lhiough unsocuioo commoicial papoi ano olhoi
shoil-loim invoslmonls (soo 1aLlo 1). Novoilholoss, oui moool capluios lho ossonlial
oconomic foaluio of shoil-loim ooLl iollovoi lhiough MMFs` oocision lo oilhoi koop
oi wilhoiaw lho monoy fiom lho Lanks.
2
iioncos laigo unoxpocloo iooomplions, il iuns lho Lank lo piolocl all ils
invoslois, ano nol jusl lhoso inilialing lho iooomplions. Locauso of lho
Lank`s lxoo piomiso, lho MMF, iocoiving nogalivo infoimalion on lho
Lank`s assols, oLlains a highoi payol foi ils invoslois if il iuns lhan if
il ooos nol.
Nolo lhal sinco lho wilhoiawals of funos fiom lho invoslois may Lo
ouo lo liquioily as opposoo lo infoimalivo ioasons, Lank Lankiuplcy may
causo inomcionl liquioalion ano a ioouclion in wolfaio.
Oui moool also gonoialos conlagion acioss Lanks as lho oivoisilca-
lion oppoilunilios oloioo Ly lho MMF may luin inlo a souico of fiagilily
whon an MMF pulls all ils funos away fiom a Lank. In pailiculai, if
lho olhoi Lank in lho oconomy is nol viaLlo on ils own givon lho con-
liacl lhal il olois, lho wholo Lanking syslom collapsos. 1his occuis
whon Lanks` invoslmonls aio (sumcionlly) iisky on lhoii own, Lul (suf-
lcionlly) safo whon lakon logolhoi. In lhis caso, lho oplimal conliacls,
which oxploil lho oivoisilcalion oppoilunilios oloioo Ly lho Lanking
syslom as a wholo, may Lo viaLlo only if invoslois supply funos lo Lolh
Lanks. In a nulsholl, wo ioonlify a now souico of conlagion, slomming
fiom lho loss of oivoisilcalion lhal lho liquioalion of ono Lank onlails
foi lho invoslois of lho olhoi. 1his channol is lhooiolically oiloionl fiom
lho inloiLank oivoisilcalion of Allon ano Galo (2000) Locauso il iolios
on lho incioaso in iiskinoss of ono Lank ouo lo lho collapso of lho olhoi,
ialhoi lhan on a oiiocl loss of funos Locauso of inloiLank ooposils. Il is
somowhal similai lo lho woik of Lagunol ano Schiofl (1000 ano 2001).
Soclion 2 oosciiLos oui moool ano chaiacloiizos lho oconomic func-
lion of MMF inloimooialion. Soclion 8 sluoios lho olocl of an unox-
pocloo wilhoiawal of funos fiom lho lnancial syslom. Soclion 4 shows
lhal an MMF-inloimooialoo lnancial syslom is moio fiagilo lhan ono
wilh oiiocl lnanco. Soclion concluoos. 1ho pioofs aio in lho appon-
oix.
2 TLe AodeI
2.1 TecLnoIogy and IreIerences
Wo oosciiLo oui oconomy lisl wilh oiiocl lnanco ano lhon wilh MMF
inloimooialion. 1hoio aio lwo iogions, ano 1. In oach iogion, lhoio is
a conlinuum of (wholosalo oi inslilulional) invoslois of mass `, which
can Lo inloipioloo as uninsuioo wholosalo invoslois,
4
foi a lolal popula-
4
Agonls supplying funos lo Lanks aio noimally iofoiioo lo as ooposilois, who
ooposil oi wilhoiaw lhoii funos. In conliasl, agonls supplying funos lo MMFs aio
noimally iofoiioo lo as invoslois, who puichaso oi ioooom shaios of lho MMF. In
oiooi nol lo saoolo lho ioaooi, fiom now on wo will uso lho loim 'invoslois,' who
8
Figuio 1:
lion 2`. Lach invosloi is onoowoo wilh $1 of cash. In oach of lho lwo
iogions lhoio is ono Lank, Lank ano Lank 1. 1ho sliucluio of lho
oconomy is oopicloo in Figuio 1.
1hoio aio lhioo oalos, 0, 1, ano 2, ano a uniquo gooo lhal can
Lo consumoo, sloioo, oi invosloo. Lvoiyono in lho oconomy can uso
sloiago, which ioluins ono unil of lho gooo al oalo t 1, foi oach unil
invosloo al oalo t, t = 0. 1. In conliasl, lho invoslmonl lochnology is
availaLlo only lo Lanks. Wo consiooi an oconomy whoio lho ioluins of
lho invoslmonls of lwo Lanks can Lo oilhoi high oi low ano aio poifoclly
nogalivoly coiiolaloo. Wo assumo lhis in oiooi lo maximizo lho gains
fiom oivoisilcalion ano simplify lho moool. 1ho ioluins of lho lwo
Lanks poi unil invosloo aio as follows:
Ioluin Ioluin
Lank Lank 1
IioLaLilily 12 1
1
1
1
IioLaLilily 12 1
1
1
1
wilh 1
1
1 1
1
. Sinco lho lwo slalos of lho woilo aio oqually
likoly, lho nol piosonl valuo of a unil of invoslmonl is lho samo foi lho
lwo Lanks. As a iosull, il is oplimal lo supply an oqual amounl of funos
lo Lolh Lanks al oalo 0. Invoslmonl can also Lo liquioaloo al oalo 1, in
which caso il ioluins 0 _ : _ 1
1
poi unil invosloo.

may 'supply' oi 'wilhoiaw' lhoii funos fiom lho MMF oi fiom lho Lank in iofoionco
lo Lolh oiiocl lnanco ano lho MMF-inloimooialoo oconomy.

1ho assumplion is naluial if wo inloipiol lho Lanks as invosling in lnancial assols

al oiloionl maluiilios, such as a loan, lhal il liios lo soll in an unmoooloo maikol.
Locauso of asymmoliic infoimalion, maikol pailicipanls may nol wanl lo puichaso
lho loans al a piico such lhal r 1

.
4
In oach of lho lwo iogions, invoslois aio suLjocl lo piofoionco shocks:
wilh pioLaLilily : invoslois musl consumo al oalo 1 (impalionl" in-
voslois), ano wilh pioLaLilily 1 : lhoy musl consumo al oalo 2 (pa-
lionl" invoslois). 1ho ioalizalion of lho shock lo lhoii piofoioncos al oalo
1 is piivalo infoimalion. Foi simplicily`s sako, wo assumo lhal invoslois
havo logaiilhmic ulilily funclion, so lhal lhoii oxpocloo ulilily is
: log (c
1
) (1 :) log (c
2
) .
whoio c
1
ano c
2
oonolo oalo-1 ano oalo-2 consumplion, iospoclivoly.
Fiom lho law of laigo numLois, a fiaclion : of agonls consumo al oalo
1 ano a fiaclion (1 :) al oalo 2.
2.2 TLe OtInaI Contract vItL DIrect FInance
Wo lisl ooloimino lho oplimal conliacl unooi oiiocl lnanco. As is
slanoaio in lhis liloialuio, Lanks aio suLjocl lo a zoio-pioll conoilion
ano, unooi oiiocl lnanco, chooso lho conliacls lo maximizo lho oxpocloo
ulilily of invoslois.
1o simplify nolalion, wo oxpioss all quanlily vaiiaLlos poi oollai
supplioo lo lho Lanking syslom. In pailiculai, wo oonolo Ly i lho lolal
invoslmonl poi oollai Ly lho lwo Lanks. Moioovoi, wo assumo lhal
1
1
1
1
2
1. (1)
lhal is, lho oxpocloo nol piosonl valuo of oach Lank`s invoslmonl is
posilivo. 1his conoilion, as wo show in lho apponoix, guaianloos lhal
lho oplimal lovol of invoslmonl i is posilivo, sinco lho iisk of Lanks`
long-loim lochnologios can Lo complololy oivoisiloo away.
1ho oplimal conliacl ano lho oplimal invoslmonl lovol aio: c
1
= 1.
c
1
2
= 1
1
. c
1
2
= 1
1
. ano i = 1 :. whoio c
1
2
ano c
1
2
iopiosonl oalo-2
consumplion if lho Lank has a high ano a low ioluin, iospoclivoly.
6
1ho
oplimal conliacl implios lhal lho Lanks sloio onough funos lo salisfy
wilhoiawals fiom impalionl invoslois only ano invosl all lho iomaining
funos in lho long-loim lochnology. Nolo lhal sinco Lanks havo poifocl
nogalivoly coiiolaloo ioluins, unooi lho oplimal conliacl, invoslois will
ooposil an oqual amounl in oach Lank, which, in luin, will invosl a
fiaclion (1:) in ils long-iun lochnology, lhus allowing palionl invoslois
a ooloiminislic ioluin
c
1
2
c
1
2
2
=
1
1
1
1
2
.
1ho oivoisilcalion oppoilunilios lhal aiiso fiom invosling in Lolh
Lanks may luin inlo a souico of fiagilily if a Lank is nol viaLlo on ils
6
Soo lho apponoix foi lho ooiivalion.

own givon lho conliacls lhal il olois. Foimally, lhis will occui if palionl
invoslois oo nol wanl lo wilhoiaw funos fiom ono Lank ano wail in lho
olhoi voisus wilhoiawing fiom Lolh Lanks. 1hal is, if:
log(0.c
1
0.c
1
) 0. log(0.c
1
0.c
1
2
) 0. log(0.c
1
0.c
1
2
). (2)
Givon lho oplimal conliacl, conoilion (2) Locomos:
log(1) = 0 0. log(0. 0.1
1
) 0. log(0. 0.1
1
).
which is salisloo as long as
1
1
<
3 1
1
1 1
1
. (8)
In lho iosl of lho papoi, wo assumo lhal conoilion (3) holos, lhal is, lhal
Lanks aio nol viaLlo on lhoii own. Inluilivoly, conoilion (3) ioquiios lhal
1
1
cannol Lo gioaloi lhan (oi oqual lo)
3 1
1
1 1
1
Locauso, olhoiwiso, oach
Lank woulo Lo so piollaLlo lhal lho conliacl il olois can slano on ils
own.
1ho conoilion (1) foi an inloiioi solulion foi i ano lho conoilion (3)
lhal conliacls aio nol viaLlo sopaialoly oslaLlish a iango foi 1
1
:
2 1
1
< 1
1
<
3 1
1
1 1
1
.
which is always foasiLlo foi any 1
1
.
7
2.3 AAF InternedIatIon
1ho sliucluio of lho oconomy wilh MMF inloimooialion is similai lo
lho ono unooi oiiocl lnanco. Howovoi, in oach iogion ano 1, lhoio
is ono MMFMMF ano MMF 1lhal channols lho funos of ils
iogion lo lho lwo Lanks. Lach MMF maximizos lho oxpocloo ulilily of
ils invoslois Ly invosling in Lanks` ooposils (iocall lhal only Lanks can
invosl in lho long-loim lochnology) anooi inlo lho sloiago lochnology.
1ho sliucluio of lho oconomy wilh MMF inloimooialion is oopicloo in
Figuio 2.
1ho iisk-oivoisilcalion pioLlom ooos nol chango whon wo inlioouco
MMFs in lho oconomy. As a iosull, unooi lho oplimal conliacl, lho
7
1ho oqualily:
2 1

=
8 1

1 1

,
has lwo oqual iools 1

= 1, ano il is always salisloo foi any 1

0.
6
Figuio 2: 1ho oconomy wilh MMF inloimooialion.
lnal consumplion foi oaily ano lalo invoslois musl Lo lho samo as wilh
oiiocl lnanco. Il is oasy lo show lhal lhis can Lo accomplishoo as
long as lho conliacls lhal lho lwo Lanks oloi lo lho MMFs aio lho
samo as lhoso oloioo lo lho wholosalo invoslois wilh oiiocl lnanco.
Analogously, lho conliacls lhal lho MMFs oloi lo lhoii invoslois musl
simply aggiogalo lho payouls fiom lho lwo Lanks: lho conliacl poi oollai
invosloo lhal oach MMF olois is c
AA1
1
= 1. ano c
AA1
2
=
1
1
1
1
2
.
1hal is, lho MMFs will oloi lhoii invoslois claims ioooomaLlo al pai al
oalo 1. Finally, MMFs musl shaio all lho funos lhoy collocl fiom lhoii
invoslois oqually Lolwoon lho lwo Lanks.
In oiooi lo unooislano lho iolo of MMF inloimooialion in lho ocon-
omy, lol us consiooi lho caso in which Lanks musl Lo moniloiooscioonoo;
olhoiwiso, lhoii ioluin is zoio al oalo 2. 1ho nooo lo moniloi lho Lanks
coulo aiiso fiom lho facl lhal lho opacily of Lank loans allows lhom lo
unooiiopoil lho ioluin lo lho long-loim lochnology anooi olois scopo
foi moial hazaio lo Lank managois. Il is woll known lhal sinco mon-
iloiing has a lxoo-cosl oimonsion, lho ouplicalion of moniloiing cosls
lhal oiiocl lnanco onlails may Lo iooucoo whon funos aio inloimooialoo
lhiough a oologaloo moniloi (Diamono 1084). 1hal is, MMF inloi-
mooialion allow invoslois lo savo on moniloiing cosls ano, as a iosull,
incioaso lhoii lovol of consumplion ano wolfaio, whilo al lho samo limo
lolling lhom onjoy lho gains fiom oivoisilcalion.
8
8
1his is liuo as long as lho cosl of moniloiing lho MMF is lowoi lhan lhal of moni-
loiing Lanks, which is gonoially lho caso sinco MMFs invosl in lxoo-incomo socuiilios
7
In lho noxl soclion wo show lhal MMF inloimooialion also makos
lho Lanking syslom moio fiagilo.
3 An \nexected VItLdravaI oI Funds
3.1 InIornatIon ArrIvaI and AggregatIon
1ho fiagilily of an MMF-inloimooialoo syslom can Lo capluioo Ly con-
siooiing lho olocl of an unoxpocloo wilhoiawal of funos in lho oconomy
wilh oiiocl lnanco ano in lhal wilh MMF inloimooialion.
Lol us assumo lhal al oalo 1 somo palionl invoslois unoxpoclooly
wilhoiaw lhoii funos. 1hoy oo so oilhoi Locauso lhoy havo iocoivoo a
liquioily shock, i.o., somo pioviously palionl invoslois Locomo impalionl
ano musl consumo al oalo 1, oi Locauso lhoy havo iocoivoo a poifoclly
infoimalivo signal lhal lho ioluin of lho invoslmonl of lho Lank in lhoii
iogion is 1
1
. 1his wilhoiawal, which is unoxpocloo ano honco is in oxcoss
of lho liquioily availaLlo al oalo 1, has a oiloionl impacl on lho slaLil-
ily of lho syslom unooi oiiocl lnanco ano unooi MMF-inloimooialoo
lnanco.
Unooi oiiocl lnanco, lho fiaclion of funos wilhoiawn in oxcoss of
: may Lo sumcionlly low so as nol lo push lho Lank inlo insolvoncy
ano lhoiofoio nol lo alloi lho oquiliLiium. Howovoi, whon invoslois
unoxpoclooly ioooom fiom lho MMF, lhoii aclions iopiosonl a noisy
signal on lho slalo of lho woilo foi lho MMF lo inloipiol. Fiom lho
sizo of lho unoxpocloo iooomplions in oxcoss of :, lho MMF will upoalo
ils piioi Loliof on lho ioluin of lho long-loim invoslmonl of lho Lank in
ils own iogion, ano il may iun lhal Lank Ly pulling all ils funos away,
lhoioLy pushing il inlo Lankiuplcy.
Moio foimally, wo assumo lhal, wilh zoio pioLaLilily, a posilivo moa-
suio of palionl invoslois fiom iogion wilhoiaw lhoii funos al oalo 1
fiom Lank oi, unooi MMF inloimooialion, fiom lho MMF in iogion
.
0
1his assumplion is in lho spiiil of Allon ano Galo (2000), who con-
siooi lho ioalizalion of an aooilional slalo of naluio lhal was assignoo a
pioLaLilily zoio al oalo 0.
10
(soo 1aLlo 1). Wo oio nol incoipoialo lho moniloiing cosl inlo oui lho moool sinco
il unnocossaiily complicalos lho nolalion; a moool lhal incluoos moniloiing cosls is
availaLlo on ioquosl fiom lho aulhois. Nolo also lhal oivoisilcalion can Lo achiovoo
lhiough lho inloiLank maikol; il is oasy lo show, howovoi, lhal MMF inloimooialion
gonoially savos on moniloiing cosls also wilh iospocl lo inloiLank lnanco.
0
Of couiso, sinco ovoiylhing is symmoliical, nolhing woulo chango if lho unox-
pocloo wilhoiawal of funos occuiioo in iogion 1.
10
Moio ioconlly, Gonnaioli ol. al (2012) aiguoo lhal invoslois may nol lako inlo
consiooialion coilain highly impioLaLlo iisks, such as lho pioLaLilily lhal lho shaio
piico of a monoy maikol mulual funo may fall Lolow 1.
8
As a iosull of lho shock , lho lolal amounl of wilhoiawals al oalo
1 fiom iogion `s invoslois is : (1 :). Nolo lhal, sinco wo assumoo
lhal conoilion (3) holos, lhal is, lhal Lank 1`s conliacl is nol viaLlo on
ils own, agonls iocoiving nogalivo infoimalion aLoul Lank will also
wilhoiaw fiom Lank 1 in lho oiiocl-lnanco caso.
11
1ho pioLaLilily lhal lho unoxpocloo wilhoiawal is infoimalivo is
incioasing in . lho oLsoivoo lovol of unoxpocloo wilhoiawal ilsolf:
1:(Shock ouo lo infoimalional ioason) = ,(). ,

() 0
lhal is, lho highoi lho fiaclion of wilhoiawals in oxcoss of :, lho moio
likoly il is lhal il happons foi infoimalion ioasons. Nolo lhal in oiooi
lo koop lho algoLia simplo, fiom now on wo will consiooi lho caso
,() =
lhal is, lho pioLaLililios lhal lho unoxpocloo wilhoiawal is infoimalivo
oi lhal il is ouo lo a piofoionco shock aio ano (1 ). iospoclivoly,
whoio (1:) is lho oLsoivoo lovol of unoxpocloo wilhoiawal ilsolf.
12
All
lho iosulls wo piosonl, howovoi, holo foi any incioasing funclion ,().
Unooi MMF inloimooialion, MMF soos lho unoxpocloo wilhoiawal
of funos Ly ils invoslois ano inloipiols lhis as (impoifocl) Lao nows on
lho ioluin of lho assols of Lank . In pailiculai, afloi oLsoiving lho
unoxpocloo wilhoiawal (1 :). lho MMF upoalos lho joinl pioL-
aLililios lhal Lank ano Lank 1 havo a high oi a low ioluin in lho
following mannoi:
1:(1
1

. 1
1
1
[) =0() 0(1 ) = 0.
1:(1
1

. 1
1
1
[) =0() 0.(1 ) = 0.(1 ).
1:(1
1

. 1
1
1
[) =0.() 0(1 ) = 0..
1:(1
1

. 1
1
1
[) =0.() 0.(1 ) = 0..
Nolo lhal whon lho shock is infoimalivo, lho ioloaso of infoimalion is
nol aLoul lho slalo of naluio; ialhoi, il is aLoul lho ioluin of ono of
lho lwo Lanks (Lank ).
18
In olhoi woios, lho pioLaLilily of lho ioluin
11
Nolo lhal nogalivoly infoimoo palionl invoslois will always lno il convonionl lo
wilhoiaw Locauso c

(as wo oxplain Lolow, ovon if Lank goos inlo Lankiuplcy,

infoimoo palionl invoslois will always Lo aLlo lo iocoup c

).
12
In an aooonoum availaLlo on ioquosl fiom lho aulhois, wo show lhal )() =
can Lo ooiivoo fiom a simplo infoimalional sliucluio.
18
In olhoi woios, lho zoio-pioLaLilily ovonl consisls of a chango in lho ioluins lo
lho long-iun lochnologios in lho lwo slalos of naluio, which Locomo (1

, 1

) ano
(1

, 1

).
0
of Lank 1 Loing high oi low is nol alocloo Ly lho aiiival of nogalivo
infoimalion on Lank . In facl, afloi oLsoiving (1:), lho conoilional
pioLaLilily of Lank 1 Loing gooo oi Lao is nol alocloo. 1hal is,
1:(1
1
1
[) = 1:(1
1
1
[) = 0..
Novoilholoss, sinco lho conliacl lhal Lank 1 olois is nol viaLlo on ils
own, Locauso of conoilion (3), lho oosliuclion of oivoisilcalion oppoi-
lunily slomming fiom lho ioloaso of infoimalion on Lank may also
sono Lank 1 inlo Lankiuplcy, an issuo lhal wo will analyzo Lolow. 1hal
is, lho Lankiuplcy of Lank 1 occuis nol Locauso of any infoimalion on
Lank 1`s ioluin, Lul as a iosull of lho Lankiuplcy of Lank .
Nolo lhal lho assumplion lhal invoslois in iogion can only Lo in-
foimoo on Lank (ano lhal lho MMF in iogion knows as much) is
usoful lo highlighl lho mochanism lhiough which conlagion ouo lo loss of
oivoisilcalion oppoilunilios occuis, lhal is, in claiifying lhal il is a sopa-
ialo channol fiom infoimalional conlagion. Shoulo wo assumo lhal, wilh
a givon pioLaLilily, infoimoo wilhoiawois in iogion iocoivo a signal on
Lank 1. lho mochanism of MMF-inoucoo lnancial fiagilily woulo nol
chango, Lul conlagion woulo occui foi a mix of infoimalional ano loss-
of-oivoisilcalion ioasons. Finally, nolo lhal lho ioloaso of infoimalion
on Lank makos lho conliacl oloioo Ly Lank 1 unoosiiaLlo. 1his
is iominisconl of lho poinl maoo Ly Hiishloifoi (1071) on infoimalion
having nogalivo wolfaio impacl Locauso il can impooo insuianco.
Finally, lho facl lhal unoxpocloo wilhoiawal is an impoifocl signal
on lho Lank long-loim invoslmonl gonoialos confounoing" as in Chaii
ano Jagannalhan (1088). Confounoing is oosiiaLlo in oui moool Locauso
olhoiwiso any ioalizalion of , howovoi small, woulo gonoialo lho collapso
of Lank ano also lho collapso of Lank 1 Locauso of assumplion (3).
3.2 Hankrutcy
1ho oxcoss wilhoiawal of funos may causo Lank Lankiuplcy in oui ocon-
omy. 1o sluoy ils impacl on lho Lanking syslom, wo nooo lo mako somo
assumplions on how lho Lanks` assols aio splil in caso of Lankiuplcy. In
pailiculai wo assumo lhal:
- Lanks aLioo Ly lho soquonlial soivico consliainl whon facing wilh-
oiawals al oalo 1, Lolh unooi oiiocl lnanco ano in lho MMF-inloimooialoo
oconomy.
- Ialionl invoslois wilhoiawing lhoii funos oaily oo so al lho Lo-
ginning of lho quouo. 1his capluios lho nolion lhal sinco lhoy aio po-
lonlially infoimoo aLoul Lank assol ioluins, lhoy may Lo aLlo lo jump
ahoao of lho lino.
14
1ho assumplion iolocls lho facl lhal inslilulional
14
Nolo lhal liquioily wilhoiawois will also liy lo jump ahoao of lho quouo as lhoy
10
invoslois aio piono lo iun in a ciisis.
- Analogously ano foi lho samo ioasons, if ono MMF makos unox-
pocloo wilhoiawals, il is lisl in lho quouo wilh iospocl lo lho olhoi
MMF.
1
Wo now conliasl lho olocl of lho unoxpocloo wilhoiawal of funos
(1 :) in an oconomy wilh oiiocl lnanco ano ono wilh MMF inloi-
mooialion.
3.2.1 Hankrutcy vItL DIrect FInance
In lho caso of oiiocl lnanco, lho unoxpocloo wilhoiawal of funos fiom
Lank will push il inlo Lankiuplcy if lho piopoilion of palionl in-
voslois who wilhoiaw lhoii funos oaily is such lhal:
(:
(1 :)
2
)c
1
1 i :i. (4)
1hal is, Lankiuplcy will occui whon lho Lank`s oalo-1 liaLililios, poi
unil ooposiloo in lho Lank, (LHS of 4) oxcooo ils oalo-1 assols (IHS).
1his conoilion, givon lho oplimal conliacl oosciiLoo aLovo, Locomos:
:
(1 :)
2
: :(1 :).
Honco, lho Lank goos Lankiupl if ano only if 2:. Nolo lhal sinco
(0. 1) . a nocossaiy conoilion foi Lankiuplcy lo occui unooi oiiocl
lnanco is
: <
1
2
. ()
Fiom now on, howovoi, wo conconlialo on ioalizalions of such lhal
lho Lank ooos nol go Lankiupl wilh oiiocl lnanco, ano wo show lhal
lho samo ioalizalions of may insloao liiggoi Lankiuplcy unooi MMF
inloimooialion. 1hal is, wo assumo:
_ 2:. (6)
Lol us mako lwo oLsoivalions. Fiisl, sinco wo assumoo lhal lho
piopoilion
(1)q
2
of palionl invoslois who unoxpoclooly wilhoiaw al
oalo 1 aio oaily in lho quouo, lhoy will Lo aLlo lo wilhoiaw c
1
= 1 as
long as
aio awaio lhal lho LankMMF may nol Lo aLlo lo soivo lalocomois if lhoio aio oxcoss
wilhoiawals al limo 1.
1
1hoso assumplions allow us lo chaiacloiizo lho oquiliLiium in lho oconomy in
lho simplosl possiLlo way. As will Lo cloai, howovoi, lho fiagilily of an MMF-
inloimooialoo oconomy ooos nol slom fiom lho pailiculai Lankiuplcy assumplion
lhal wo aooploo, Lul fiom lho aLilily of MMFs lo aggiogalo infoimalion among
lhoii invoslois.
11
(1 :)
2
_ : :(1 :). (7)
whoio lho LHS of (7) is lho amounl of funos wilhoiawn al oalo 1 Ly
lho palionl invoslois, ano lho IHS aio lho Lank`s assols al oalo 1.
16
OLviously, as long as lho lovol of wilhoiawal is such lhal lho Lank is nol
pushoo inlo Lankiuplcy, lhal is, as long as _ 2:, lho Lank will always
Lo aLlo lo pay c
1
= 1 lo lho palionl invoslois wilhoiawing lhoii funos
oaily. As a iosull, as monlionoo aLovo, an infoimoo palionl invosloi
knowing lhal lho ioluin of Lank `s assols is low will lno il oplimal lo
wilhoiaw sinco c
1
c
1
2
.
Socono, if Lankiuplcy occuis, impalionl invoslois (fiom Lolh Lanks
ano 1) will nol nocossaiily gol c
1
sinco lhoio aio nol onough iosouicos
in lho Lank, ovon afloi liquioaling all lho long-loim assols. Moioovoi,
ovon if Lankiuplcy ooos nol occui, palionl invoslois will nol iocoivo lho
oplimal conliacl al oalo 2 sinco somo (oi all) of lho funos havo Loon
liquioaloo.
As a lnal iomaik, oLsoivo lhal sinco : _ 1
1
, lhon Lank will novoi
liquioalo all ils long-loim assols whon il oLsoivos an oxcoss wilhoiawal
of funos; il will only liquioalo whalovoi is nooooo lo iopay lho piopoilion
of palionl invoslois who wilhoiaw lhoii funos oaily.
3.2.2 Hankrutcy vItL AAF InternedIatIon
Lvon if Lolh lho MMFs ano lho Lanks issuo lho samo claims oomano-
aLlo al pai al oalo 1, upon oLsoiving unoxpocloo iooomplions MMF
Lohavos oiloionlly fiom lho Lank in lho oiiocl-lnanco caso. In facl, lho
MMF can wilhoiaw ils funos fiom Lank al lho conliacl c
1
= 1, whilo
in oiiocl lnanco, whon Lank liquioalos oaily lo mool lho unoxpocloo
wilhoiawal (1 :). il ooos so al : < 1. 1hoiofoio, if afloi oLsoiving
lho unoxpocloo iooomplions (1 :), MMF Loliovos lhal Lank

s
ioluin is low wilh high onough pioLaLilily, il will wilhoiaw all ils funos,
ano nol only whal is nooooo lo mool lho unoxpocloo iooomplions. 1his
amplilcalion mochanism makos lho MMF-inloimooialoo sliucluio moio
unslaLlo lhan oiiocl lnanco.
Of couiso, lho facl lhal MMF wilhoiaws all ils funos fiom Lank
ooos nol nocossaiily imply lhal Lank is Lankiupl, which will only
happon whon:
16
1ho conoilion (7) compuloo foi lho highosl possiLlo lovol of wilhoiawal, i.o., foi
= 1, Locomos:
(1 ) < 2( r(1 )),
which is always liuo foi

.
12
(:
(1 :)
2
)c
1
1 i :i.
which, givon lho oplimal conliacl, Locomos:
(:
(1 :)
2
) : :(1 :).
oi : <
1
2
.
Nolo lhal : <
1
2
is lho samo as conoilion (), which makos Lankiuplcy
possiLlo in oiiocl lnanco foi a high onough ioalizalion of .
Nolo lhal Lankiuplcy is nol lho iosull of a sunspol (o.g., a wavo of
possimism), Lul sloms fiom lho unoxpocloo wilhoiawal of funos (1:)
Ly palionl invoslois ano, in lho MMF-inloimooialoo oconomy, fiom lho
infoimalion lhal such an unoxpocloo wilhoiawal convoys lo lho MMF.
3.3 TLe AAF HeactIon to an \nexected VItL-
dravaIs oI Funds
Wo now invosligalo how MMF will Lohavo afloi oLsoiving an unox-
pocloo wilhoiawal of funos (1 :). 1ho MMF will Lo aLlo lo oloi c
1
lo all ils invoslois wilhoiawing lhoii funos al oalo 1 as long as:
(: (1 :)) c
1
_ 2(: :(1 :)). (8)
whoio lho LHS of (8) is lho wilhoiawal of funos fiom MMF ano lho
IHS aio lho comLinoo assols of Lolh Lanks ano 1 al oalo 1. Sinco
c
1
= 1 unooi lho oplimal conliacl, (8) Locomos
(1 :) _ : 2:(1 :). (0)
Nolo lhal sinco wo aio only consiooiing ioalizalions of such lhal lho
Lanking syslom ooos nol go Lankiupl unooi oiiocl lnanco
17
(i.o., _
2:), conoilion (9) Locomos:
17
In conliasl, foi = 1, lho conoilion woulo Lo:
1 < 2r 2r

_
1 2r
2 2r
_
Nolo lhal, in lhis caso, if lho MMF wilhoiaws all ils funos oaily al lho ialo c

fiom
Lank ano 1, lho Lanks will novoi go Lankiupl. 1his is Locauso all lhoii comLinoo
assols 2( r(1 )) aio oqual lo oi gioaloi lhan lho MMF maximum wilhoiawal,
which is oqual lo (1 ).
18
(1 :)2: _ : 2:(1 :).
which, as in lho caso of lho analogous conoilion wilh oiiocl lnanco, is
always salisloo. As a iosull, lho MMF is suio lhal Lolh impalionl ano
palionl invoslois iooooming oaily iocoivo c
1
. 1his allows us lo sluoy
lho ioaclion of lho MMF upon oLsoiving lho unoxpocloo iooomplions
(1:), whilo oisiogaioing lho wolfaio of lho invoslois iooooming oaily.
In pailiculai, lho MMF musl chooso lho piopoilion Ly which il mools
lho unoxpocloo iooomplions (1 :) Ly wilhoiawing funos fiom Lank
ano fiom Lank 1. 1hoso piopoilions, which wo oonolo Ly ` ano
(1 `). iospoclivoly, aio lho iosulls of lho MMF io-oplimizalion upon
oLsoiving lho unoxpocloo wilhoiawal of funos. Sinco lho MMF knows il
will Lo aLlo lo pay ils invoslois iooooming oaily lho amounl c
1
= 1. lho
piopoilions ` ano (1`) aio ooiivoo only Ly looking al lho wolfaio of lho
iomaining palionl invoslois (i.o., (1 :)(1 )). Nolo lhal allhough lho
oxcoss wilhoiawal of funos occuis in iogion (ano wilh pioLaLilily il
iolocls Lao infoimalion on Lank A`s long-loim invoslmonl), in gonoial
lho MMF will oocioo lo mool lho unoxpocloo iooomplions Ly pulling
funos fiom Lolh Lanks. 1ho ioason is lhal allhough lho oxpocloo ioluin
on Lank assols has oocioasoo (whoioas lhal on Lank 1 assols has nol),
in gonoial il may nol Lo oplimal lo mool lho unoxpocloo iooomplions
oxclusivoly fiom Lank , as lho lwo Lanks piovioo a hoogo ono againsl
lho olhoi. 1ho oplimal ` is givon Ly
` = max(
(
1

1)(1 )
v(

1)
(1)

(2 )(
1

1)
. 1).
In lho inloiosl of spaco, wo oo nol iopoil lho ooiivalion of lho oplimal
lovol of ` in lho main loxl of lho papoi, Lul oosciiLo il in lho apponoix.
Nolo lhal, as shown in lho apponoix, if = 0. lhon ` =
1
2
, which moans
lhal if lho unoxpocloo wilhoiawal of funos is low onough nol lo conlain
any infoimalion on Lank , il will Lo mol Ly wilhoiawing funos oqually
fiom Lolh Lanks. Nolo also lhal if = 1. lhon ` = 1. 1his moans lhal
if lho unoxpocloo wilhoiawal is so high lhal lho MMF knows lhal lho
ioluin on Lank assols is low, il will Lo mol Ly wilhoiawing fiom Lank
only.
Iocall lhal lho lolal amounl wilhoiawn al oalo 1 Ly MMF is
: (1 :). Sinco lho Lanks havo invosloo in lho long-loim assol a
fiaclion i = 1 : of oach unil ooposiloo, lho ovoiall liquioalion of
lho long-loim assols poi unil ooposiloo in lho Lanking syslom is
(1)q
v
.
Givon lho oplimal fiaclion ` wilhoiawn Ly MMF fiom Lank . lho
wilhoiawal poi unil of ooposil fiom Lank is `(: (1 :)) ano lhal
14
fiom Lank 1 is (1 `)(: (1 :)). Moioovoi, lho liquioalion of Lank

s assols yiolos `
(1)q
v
: ano lho liquioalion of Lank 1

s assols yiolos
(1 `)
(1)q
v
. Locauso of lho liquioalion of Lolh Lanks` assols lo mool
lho unoxpocloo wilhoiawal of funos, lho conliacls lhal lho Lanks can
aloio lo oloi al oalo 2 will chango. In pailiculai, lho payols oloioo Ly
Lank aio:
c
1
2,
=max(1
1
(1 `
(1 :)
:
). 0) (10)
c
1
2,
=max(1
1
(1 `
(1 :)
:
). 0). (11)
ano lho payols oloioo Ly Lank 1 aio:
c
1
2,1
=max(1
1
(1 (1 `)
(1 :)
:
). 0). (12)
c
1
2,1
=max(1
1
(1 (1 `)
(1 :)
:
). 0). (18)
4 TLe FragIIIty oI AAF InternedIatIon
Wo now show lhal lhoio aio lovols of wilhoiawals ano iooomplions such
lhal lhoio is no Lank Lankiuplcy wilh oiiocl lnanco, Lul Lankiuplcy
occuis wilh MMF inloimooialion. OLviously, lo sluoy lho MMF Lohav-
ioi, wo musl lako inlo accounl lhal lho unoxpocloo iooomplions (1:)
givo lho MMF infoimalion aLoul lho ioluin of lho long-loim assol in
Lank . In pailiculai, upon oLsoiving . lho MMF upoalos ils piioi on
lho ioluin of Lanks ano 1 accoioing lo lho pioLaLililios oosciiLoo in
Soclion 3.1.
Wo aio looking foi a conoilion on such lhal MMF , afloi having
iocoivoo unoxpocloo iooomplion (1:), piofois lo wilhoiaw all ils holo-
ings fiom Lank ano liiggoi ils liquioalion,
18
as opposoo lo liquioaling
only lho minimum fiom Lolh Lanks lo salisfy unoxpocloo iooomplions
ano koop lho iosl in lho Lanks. Iocall lhal lho MMF maximizos lho
oxpocloo ulilily of ils invoslois.
1ho oxpocloo ulilily of lho MMF invoslois if lho MMF oocioos lo
wilhoiaw only (1 :). ano nol lo foico Lank

s liquioalion, is:
1l
Non-Liquioalion
= (: (1 :)) n(c
1
)
. .
0
(1 (: (1 :))) (14)
_
0.(1 )n(
c
1
2,
c
1
2,1
2
) 0.n(
c
1
2,1
c
1
2,
2
) 0.n(
c
1
2,1
c
1
2,
2
)
_
.
18
Sinco wo assumoo lhal r <

, Lank will go Lankiupl if MMF wilhoiaws all

ils assols (soo Soclion 8.2.2).
1
whoio c
1
2,i
. c
1
2,i
i = . 1 aio lho payouls of Lanks ano 1 al oalo 2 afloi
MMF wilhoiaws ils funos oolnoo in (10), (11), (12), ano (13) . Nolo
lhal sinco lho MMF knows il can pay ils invoslois iooooming al oalo 1
lho amounl c
1
= 1. lho lisl loim oiops oul fiom (14).
In conliasl, lho oxpocloo ulilily of lho MMF invoslois if lho MMF
oocioos lo foico Lank inlo liquioalion is:
1l
Liquioalion
= (: (1 :)) n(c
1
) (1)
(1 (: (1 :)))
_
0.n(
c
1
2
c
1
2
) 0.n(
c
1
2
c
1
2
)
_
.
whoio
c
1
= min(
: :(1 :)
:
2

(1 :)
2
. 1) = min(2 [: :(1 :)[ . 1) (16)
is howmuch lho MMF oLlains if il foicos Lank lo liquioalo all ils assols
al oalo 1.
10
Nolo lhal if lho MMF foicos Lank inlo Lankiuplcy il
will nol nocossaiily Lo aLlo lo pay all ils invoslois c
1
= 1 ano, lhoiofoio,
gonoially, c
1
< c
1
.
20
Al oalo 1, MMF will wilhoiaw fiom Lank all ils holoings (as
opposoo lo only lho unoxpocloo wilhoiawal (1:)) if lho oxpocloo ulil-
ily of ils invoslois upon lolal wilhoiawal fiom Lank (1l
Liquioalion
)
is gioaloi lhan lho oxpocloo ulilily upon kooping funos in Lank
(1l
Non Liquioalion
).
21
1hus, wo can oslaLlish a lovol of such lhal MMF
, afloi having oLsoivoo lho unoxpocloo wilhoiawal (1 :), piofois
lo wilhoiaw all ils holoings fiom Lank ano liiggoi ils liquioalion (if
: <
1
2
), as opposoo lo liquioaling only lho minimum fiom Lolh Lanks lo
salisfy lho unoxpocloo wilhoiawal of funos.
1ho following pioposilion compaios lho slaLilily of MMF inloimooi-
alion ano oiiocl lnanco.
IroosItIon 1: Foi any valuos of 1
1
ano 1
1
salisfying conoilion
(1) ano foi : _
0.v
1v
, lhoio is an inloival of ioalizalion of foi which
Lankiuplcy occuis wilh MMF inloimooialion ano nol wilh oiiocl l-
nanco.
10
Nolo lhal r(1) aio Lank A`s assols al oalo 1; moioovoi, in lho oonominaloi
,2 is lho mass of impalionl invoslois lhal MMF has lo salisfy fiom Lank , ano
(1 ),2 is lho mass of palionl invoslois lhal MMF has lo salisfy fiom Lank
(iomomLoi lhal wo assumo MMF is lisl in lho quouo).
20
Givon lhal lho infoimalion ovonl is zoio pioLaLilily, MMF 1 will novoi wilhoiaw
in oxcoss of sinco il has no infoimalion on lho ioluin of lho long-loim assol.
21
Foi simplicily`s sako, wo assumo in lho pioofs lhal lho MMF wilhoiaws whon
lho inoqualily holos woakly.
16
1ho pioof is in lho apponoix.
Iioposilion 1 oslaLlishos lhal a MMF-inloimooialoo syslom is moio
fiagilo lhan oiiocl lnanco. 1his happons Locauso MMFs givo invoslois
oomanoaLlo liaLililios in oiooi lo salisfy lhoii liquioily nooos, which
makos MMFs liaLililios suLjocl lo iun-liko iooomplions. 1ho unox-
pocloo oaily iooomplions conlain nogalivo infoimalion on Lank `s as-
sols, which may mako il oplimal foi lho MMF lo iun lho Lank. Nolo lhal
lho MMF oocioos lo iun lho Lank in oiooi lo piolocl all ils invoslois,
ano nol jusl lhoso unoxpoclooly wilhoiawing oaily. Inoooo, givon lho
Lank`s lxoo piomiso al oalo 1, lho MMF oLlains a highoi payol foi
ils invoslois if il iuns lhan if il ooos nol. Sinco lho unoxpocloo oaily
iooomplions may Lo ouo lo liquioily as opposoo lo infoimalivo ioasons,
Lank Lankiuplcy unooi MMF inloimooialion may causo inomcionl liq-
uioalion of lho long-loim invoslmonl.
Nolo lhal, in lhis oconomy, MMF inloimooialion gonoialos lnan-
cial fiagilily ovon lhough MMFs only maximizo lho wolfaio of lhoii in-
voslois. 1ho inslaLilily ooos nol aiiso fiom any fiiclion (such as agoncy
pioLloms), Lul simply fiom lho aLilily of MMFs lo aggiogalo piivalo
infoimalion ano uso il lo lho Lonoll of ils invoslois.
As monlionoo aLovo, Lankiuplcy in an MMF-inloimooialoo oconomy
occuis Locauso lhoio is a lhiosholo of , such lhal any ioalizalion of
gioaloi lhan lhal loaos MMF lo wilhoiaw ils funos fiom Lank ano,
as a iosull, Lank collapsos. In lho following pioposilion wo piovioo
an uppoi Louno foi such a lhiosholo.
IroosItIon 2: Foi any valuos of 1
1
ano 1
1
salisfying conoilion
(1) ano foi : _
0.v
1v
, lol us oolno Ly lho lhiosholo such lhal any
ioalizalion of gioaloi lhan loaos lo Lankiuplcy unooi MMF inloimo-
oialion. Wo can show lhal
_ =
log
(1

1)(1

1)
(1

log
_
2
(

1)
_ .
1ho pioof is in lho apponoix, whoio wo also show lhal:
J
J1
1
0.
J
J1
1
0.
lhal is, incioasos wilh Lolh 1
1
ano 1
1
. Whon 1
1
is highoi, lho nog-
alivo infoimalion convoyoo Ly lho oxcoss wilhoiawal is loss impoilanl;
lhoiofoio, a highoi lovol of wilhoiawal is nooooo foi lho MMF lo causo
lho Lank`s Lankiuplcy. Similaily, whon 1
1
incioasos, lho highoi ioluin
17
in lho high slalo of lho woilo incioasos lho oxpocloo ulilily fiom nol
wilhoiawing fiom lho Lank; as a iosull, a highoi oxcoss wilhoiawal is
nooooo foi lho MMF lo causo Lankiuplcy.
4.1 ContagIon
1ho piosonco of Lanks in lho lwo iogions olois wholosalo invoslois hoog-
ing oppoilunilios. Howovoi, whon a Lank is liquioaloo, lhis hooging
oppoilunily vanishos, which may cioalo conlagion acioss lho Lanking
syslom.
In pailiculai, if lho unoxpocloo wilhoiawals of funos (1 :) aio
laigo onough lhal MMF wilhoiaws all ils funos fiom Lank . lho
MMF may also wilhoiaw fiom Lank 1. 1his happons if lho conliacl
oloioo Ly Lank 1 is nol viaLlo on ils own, givon lho conoilional in-
foimalion lhal lho MMF has on Lank 1 ioluins (soo Soclion 3.1) ano
lho facl lhal lho payoul fiom Lank A is now c
1
foi Lolh oaily ano lalo
wilhoiawois. 1his will happon if:
log(0.c
1
0.c
1
) _ (: (1 :)) log (c
1
) (17)
(1 (: (1 :)))
_
0. log
_
c
1
2,1
c
1
2
_
0. log
_
c
1
2,1
c
1
2
__
.
Whon conoilion (17) is salisloo, lho inslaLilily of MMF lnanco is con-
lagious" Locauso il gonoialos lho collapso of lho wholo Lanking syslom.
Wo oslaLlish lho following iosull:
IroosItIon 3: Foi : _
0.v
1v
ano givon assumplion (3), Lankiuplcy
of Lank liiggois Lankiuplcy of Lank 1.
1ho pioof is in lho apponoix.
Wilh lhis iosull, wo ioonlify a now souico of conlagion, slomming
fiom lho loss of oivoisilcalion lhal lho liquioalion of ono Lank onlails
foi lho invoslois of lho olhoi. 1his channol is lhooiolically oiloionl fiom
lho inloiLank oivoisilcalion of Allon ano Galo (2000) Locauso il iolios
on lho incioaso in iiskinoss of ono Lank ouo lo lho collapso of lho olhoi,
ialhoi lhan on a oiiocl loss of funos Locauso of inloiLank ooposils.
4.2 FragIIIty and ContagIon: an ExanIe
Ly moans of an numoiical oxamplo wo oslaLlish, lisl, lhal lhoio oxisls
an oconomy in which on oalo 1 an unoxpocloo iooomplion (1:) causos
Lankiuplcy unooi MMF inloimooialion, whilo a unoxpocloo wilhoiawal
of lho samo sizo ooos nol causo Lankiuplcy unooi oiiocl lnanco. Socono,
wo oslaLlish lhal conlagion can happon.
Consiooi an oconomy whoio
1
1
= 0.2 ano 1
1
= 2.
18
Assumo lhal lho liquioalion valuo : = 0.249 < 1
1
. 1hoiofoio, sinco
: < 1,2. Ly conoilion () Lankiuplcy is possiLlo unooi oiiocl lnanco.
Also assumo lhal lho fiaclion of impalionl : oquals 0.8.
Wilh a logaiilhmic ulilily funclion, lho oplimal conliacl oloioo Ly
lho Lanks is
c
1
= 1 c
1
2
= 2 c
1
2
= 0.2.
Moioovoi, sinco 1
1
<
S1

(11

)
= 2.2. Ly conoilion (8) lho oplimal con-
liacls oloioo Ly Lanks ano 1 aio nol viaLlo sopaialoly.
Consiooi a lovol of oxcoss wilhoiawal = 0.3. 1his moans lhal lho
unoxpocloo wilhoiawal is (1 :) = 0.2(0.3) = 0.07. Sinco, < 2: =
0.498, Ly conoilion () such lovol of unoxpocloo wilhoiawal ooos nol
causo Lankiuplcy in an oconomy wilh oiiocl lnanco.
Whal happons insloao wilh MMF inloimooialion Upon oLsoiving
lho unoxpocloo iooomplion, lho MMF will upoalo upwaios lho pioL-
aLilily lhal ioluin of Lank long-loim invoslmonl yiolos 1
1
= 0.2.
Givon lhis infoimalion, if MMF oocioos lo wilhoiaw only whal is
nooooo lo mool lho unoxpocloo wilhoiawal of funos fiom ils invoslois
(1:), il woulo wilhoiaw all lho funos fiom Lank ano nolhing fiom
Lank 1 (i.o.. lho oplimal ` oquals 1).
Locauso of lhis, upon oLsoiving lho wilhoiawal, Lank woulo only
Lo aLlo lo oloi
c
1
2
= 1
1
(1
(1 :)
:
) = 1.44 ano c
1
2
= 1
1
(1
(1 :)
:
) = 0.18.
whoioas Lank 1 woulo nol havo lo mooify ils payouls. As a iosull, fiom
(14) lho oxpocloo ulilily of MMF invoslois woulo Lo 0.10.
Whal woulo happon if MMF oocioos lo pull all ils funos fiom
Lank Sinco : is iolalivoly high (0.8), MMF woulo Lo aLlo lo pay
c
1
= c
1
= 1 lo all invoslois wilhoiawing oaily. As a iosull, fiom (1)
lho oxpocloo ulilily of MMF invoslois woulo Lo 0.004. highoi lhan
if MMF oocioos nol lo pull ils funos fiom Lank .
Finally il is oasy lo voiify lhal givon lho oocision lo pull oul fiom
Lank , MMF woulo also lno il convonionl lo wilhoiaw ils funos
fiom Lank 1.
22
1hal is, wo founo a lovol of unoxpocloo wilhoiawals
such lhal wilh oiiocl lnanco lhoio is no Lankiuplcy, whoioas wilh MMF
inloimooialion Lolh Lank ano Lank 1 go Lankiupl.
22
1his follows fiom lho facl lhal, unooi lho mainlainoo assumplions, lho LHS of
oqualion (17) is oqual lo 0 as
c

= min(2 [ r(1 )[ , 1) = 1
ano lho IHS of oqualion (17) is oqual lo lho oxpocloo ulilily unooi liquioalion,
namoly oqualion (1), which is oqual lo 0.004.
10
5 ConcIusIon
In lhis papoi wo show lhal MMF inloimooialion allows invoslois lo
limil lhoii oxposuio lo a singlo Lanking inslilulion ano ioap lho gains
fiom oivoisilcalion. Howovoi, a Lanking syslom inloimooialoo lhiough
MMFs is moio unslaLlo lhan ono in which invoslois inloiacl oiioclly
wilh Lanks Locauso MMFs aio lhomsolvos suLjocl lo iuns fiom lhoii
own invoslois. 1ho mochanism lhiough which inslaLilily aiisos is lho
ioloaso of piivalo infoimalion on Lank assols, which is aggiogaloo Ly
MMFs ano loao lhom lo wilhoiaw on masso fiom a Lank. Finally, wo
show lhal MMF inloimooialion is ilsolf a channol of conlagion among
Lanking inslilulions. Oui iosulls piovioo a lhooiolical unooipinning foi
lho iooa lhal an MMF-inloimooialoo lnancial syslom can Lo pailiculaily
fiagilo. 1his fiagilily has Loon lho impolus of ioconl iogulaloiy oloils
of lho inousliy Ly lho SLC ano FSOC.
Ovoi lho ioconl oocaoos, Lanks havo iolioo moio ano moio on lnan-
cial inloimooiaiios, such as monoy maikols funos, lo lnanco lhoii in-
voslmonl. Oui iosulls, suggosl lhal lhis liono, whilo piovioing invoslois
wilh valuaLlo oivoisilcalion oppoilunilios, may incioaso lho inslaLilily
of lho Lanking syslom.
6 HILIIograLy
Allon, Fianklin, ano Douglas Galo (2000), Financial Conlagion," J&:-
nn| J 1|..n| 1nnj, 108, 1, 1-88.
Chaii, V.V. ano I. Jagannalhan (1088), Lanking Ianics, Infoima-
lion, ano Ialional Lxpoclalions LquiliLiium," Jh J&:nn| J 1.nnn
48(8), 740-761.
Diamono, D.V. (1084), Financial Inloimooialion ano Dologaloo Mon-
iloiing," 1.& J 1nn. 5&J., 808-414.
Diamono, D.V. ano I. DyLvig (1088), Lank Iuns, Doposil Insui-
anco, ano Liquioily," J&:nn| J 1|..n| 1nnj, 01,8, 410-0.
Duoloy, William(2012), 'Foi SlaLilily`s Sako, IofoimMonoy Funos,'
LloomLoig.oig, Aug 14.
Gonnaioli, N., A. Shloifoi, ano I.W. Vishny (2012), Noglocloo Iisks,
Financial Innovalion, ano Financial Fiagilily." J&:nn| J 1.nnn.n| 1-
nn. 104, 42-468.
Goilhnoi, 1. (2012), Lolloi lo lho MomLois of lho Financial SlaLilily
Ovoisighl Council, Sopl 27.
Hiishloifoi, J. (1071), '1ho Iiivalo ano Social Valuo of Infoimalion
ano lho Iowaio lo Invonlivo Aclivily,' n:.nn 1nn. 1.&, 61,
61-74.
Lagunol, I. ano S. L. Schiofl (1000), Financial Fiagilily wilh Ialio-
20
nal ano Iiialional LxuLoianco," J&:nn| J `nj, :J. nnJ 1nn|.nj
81, 81-60.
Lagunol, I. ano S. L. Schiofl (2001), AMoool of Financial Fiagilily,"
J&:nn| J 1nn. Jh:j 00, 220-264.
McCaLo, I.L., M. Cipiiani, M. Holschoi, ano A. Mailin (2012), '1ho
Minimum Lalanco al Iisk: A Iioposal lo Miligalo 1ho Syslomic Iisks
Iosoo Ly Monoy Maikols Funos,' FILNY Slal Iopoil No. 64, July.
7 AendIx
7.1 TLe OtInaI Contract vItL DIrect FInance
Wo ooiivo oplimal conliacl as lho solulion lo lho plannoi pioLlom in an
oconomy wilh oiiocl lnanco. Nolo lhal allhough oach Lank ano 1
olois polonlially oiloionl conliacls
c

1
. c
,1
2
. c
,1
2
. c
1
1
. c
1,1
2
. c
1,1
2
il is liivial lo show lhal, unooi lho oplimal conliacl, Lank conliacls
woulo Lo ioonlical ano invoslois woulo invosl an oqual amounl in oach
Lank. 1hoiofoio, lo simplify nolalion, wo oonolo lho oplimal conliacl
Ly c
1
. c
1
2
. c
1
2
.
Donolo wilh : sloiago lo oalo 2 poi unil of ooposil. 1ho oplimal
conliacl is lho solulion lo lho following oplimizalion pioLlom:
`cr :n(c
1
) (1 :)[n(
c
1
2
c
1
2
2
)[.
w.i.l. c
1
. c
1
2
. c
1
2
. i. :
s.l.
oalo 1 : :c
1
= 1 i :.
oalo 2: (1 :)c
1
2
=i1
1
:.
oalo 2: (1 :)c
1
2
= i1
1
:.
i : _ 1. i _ 0. : _ 0.
whoio, iocall, lho socono ulilily loim comos fiom lho facl lhal Ly invosl-
ing
1
2
in oach Lank, ano sinco Lanks havo poifocl nogalivo coiiolalion,
palionl invoslois oLlain a ooloiminislic ioluin al oalo 2.
SuLsliluling lho oqualily consliainl
`cr :n(
1 i :
:
) (1 :)[n(
i(1
1
1
1
) 2:
2(1 :)
)[.
w.i.l. i. :
:.t
i : _ 1. i _ 0. : _ 0.
21
1ho FONCs aio:
n/(c
1
) n

(
c
1
2
c
1
2
2
)
(1
1
1
1
)
2
` =0
n/(c
1
) n

(
c
1
2
c
1
2
2
)2 j=0.
`i =0. j: = 0.
whoio `. j0
which, wilh lho naluial log ulilily funclion, Locomos

1
c
1

1
c
1
2
c
1
2
_
1
1
1
1
_
` =0

1
c
1

1
c
1
2
c
1
2
2 j=0.
`i =0. j: = 0.
whoio `. j0.
1hoio aio lhioo casos:
Caso 1), wilh : = 0. i 0.
1hon lho mulliplioi ` = 0 ano lho lisl consliainl,

1
c
1

1
c
1
2
c
1
2
_
1
1
1
1
_
= 0.
1ho solulion lo lho oplimizalion pioLlom is inloiioi ano i = 1 :.
1ho socono consliainl,

1
c
1

1
c
1
2
c
1
2
2 j = 0.
whoio j 0. Foi lho consliainl lo Lo salisloo, il musl Lo lho caso
lhal

1
c
1

2
c
1
2
c
1
2
< 0.
lhal is,

1
1

2
(1
1
1
1
)
< 0.
oi
1
1
1
1
2.
which is lho conoilion (1) foi an inloiioi solulion.
Caso 2), wilh : 0. i = 0.
1hon, lho mulliplioi j = 0. ano lho socono consliainl,

1
c
1

2
c
1
2
c
1
2
= 0.
Foi lho consliainl lo Lo salisloo, il musl Lo lho caso lhal

:
1 :

(1 :)
:
= 0, lhal is,
22
: = (1 :).
1ho lisl consliainl,

1
c
1

1
c
1
2
c
1
2
(1
1
1
1
) ` = 0.
which sinco ` _ 0 implios

:
1 :

(1 :)
:
(1
1
1
1
)
2
0.
lhal is,
1
1
1
1
2.
in which caso lho Lanks` nol piosonl valuo is smalloi lhan zoio, ano
lho oplimal conliacl implios zoio invoslmonl in lho long lochnology.
Caso 8), wilh : 0. i 0.
1hon, Lolh mullipliois j. ` = 0. ano lho consliainls Locomo:

1
c
1

1
c
1
2
c
1
2
2 = 0.
ano

1
c
1

1
c
1
2
c
1
2
_
1
1
1
1
_
= 0.
which can novoi Lo lho caso unloss 1
1
1
1
= 2.
As monlionoo in lho loxl, wo assumoo lhal conoilion (1) holos, lhal
is, 1
1
1
1
2, which implios i 0, : = 0.
7.2 TLe OtInaI VItLdravaI Ly tLe AAF
Iocall lhal MMF choosos how much lo wilhoiaw fiom Lanks ano
1 assuming lhal il can slill oLlain c
1
foi all ils invoslois iooooming
oaily (lhal is, c
1
= c
1
). 1his allows us lo oisiogaio lho wolfaio of lho
invoslois iooooming oaily fiom lho MMF . As a iosull, lho oplimal
wilhoiawal of MMF fiom lho lwo Lanks is lho iosull of lho following
maximizalion pioLlom:
`cr
&.v.t.

A
0.(1 )n(
c
1,
2
c
1,1
2
2
) 0.n(
c
1,1
2
c
1,
2
2
) (18)
0.n(
c
1,
2
c
1,1
2
2
)
s.l.
c
1,
2
= max(1
1
(1

`
(1 :)
:
). 0).
c
1,
2
= max(1
1
(1

`
(1 :)
:
). 0).
c
1,1
2
= max(1
1
(1 (1

`)
(1 :)
:
). 0).
c
1,1
2
= max(1
1
(1 (1

`)
(1 :)
:
). 0).
28
whoio

`. ano (1

`) iopiosonl lho fiaclion of wilhoiawal lhal lho ``1

will oo in Lank ano 1 iospoclivoly, ano c
i,)
2
iopiosonls oalo-2 con-
sumplion if lho ioluins aio low oi high, i = 1. H, Ly Lank , = . 1.
Lol us analyzo lho lhioo loims in (18) wo nooo lo maximizo sopaialoly:
1oim 1:
c
1,
2
c
1,1
2
2
=
(1
1
(1

`
(1)q
v
)) (1
1
(1 (1

`)
(1)q
v
))
2
=
1
1
2
(
1
1
1
1
(1

`
(1 :)
:
) (1 (1

`)
(1 :)
:
)) =
1
1
2
(
1
1
1
1
1)
1
1
2
(1 :)
:
(

`(
1
1
1
1
1) 1).
which is oocioasing in

`.
1oim 2:
c
1,1
2
c
1,
2
2
=
(1
1
(1 (1

`)
(1)q
v
)) (1
1
(1

`
(1)q
v
))
2
.
=
1
1
2
(
1
1
1
1
(1 (1

`)
(1 :)
:
) (1

`
(1 :)
:
)).
=
1
1
2
(
1
1
1
1
1)
1
1
2
(1 :)
:
((1

`)(
1
1
1
1
1) 1).
which is incioasing in

`.
1oim 3:
c
1,1
2
c
1,
2
2
=
(1
1
(1 (1

`)
(1)q
v
)) (1
1
(1

`
(1)q
v
))
2
=1
1

1
1
2
(1 :)
:
.
which is inooponoonl fiom

`. 1hoiofoio, lho solulion lo lho maximizalion

of (18) is lho solulion lo lho maximizalion of lho lisl lwo loims. 1hal
is,
0.(1 )n(
1
1
2
(
1
1
1
1
1)
1
1
2
(1 :)
:
(

`(
1
1
1
1
1) 1))
0.n(
1
1
2
(
1
1
1
1
1)
1
1
2
(1 :)
:
((1

`)(
1
1
1
1
1) 1)).
oi
(1 )n(
1
2
(
1
1
1
1
1)
1
2
(1 :)
:
(

`(
1
1
1
1
1) 1))
n(
1
2
(
1
1
1
1
1)
1
2
(1 :)
:
((1

`)(
1
1
1
1
1) 1)).
24
which, wilh a logaiilhmic ulilily funclion, Locomos:
(1 ) log(
1
2
(
1
1
1
1
1)
1
2
(1 :)
:
(

`(
1
1
1
1
1) 1))
log(
1
1
2
(
1
1
1
1
1)
1
1
2
(1 :)
:
((1

`)(
1
1
1
1
1) 1)).
which is oquivalonl lo
(1 ) log((
1
1
1
1
1)
(1 :)
:
(

`(
1
1
1
1
1) 1))
log((
1
1
1
1
1)
(1 :)
:
((1

`)(
1
1
1
1
1) 1)).
1ho FONC of lho maximizalion pioLlom is:
(1 )

(1)q
v
(
1

1)
((
1

1)
(1)q
v
(

`(
1

1) 1))

(1)q
v
(
1

1)
((
1

1)
(1)q
v
((1

`)(
1

1) 1))
= 0.
which is oquivalonl lo:
(1 )
_
((
1
1
1
1
1)
(1 :)
:
((1

`)(
1
1
1
1
1) 1))
_

_
((
1
1
1
1
1)
(1 :)
:
(

`(
1
1
1
1
1) 1))
_
= 0.
1hon:
(1 )
_
((
1
1
1
1
1)
(1 :)
:
((1

`)(
1
1
1
1
1) 1))
_
(10)
_
((
1
1
1
1
1)
(1 :)
:
(

`(
1
1
1
1
1) 1))
_
= 0.
Lol us oonolo \ =
(1)q
v
, ano oLsoivo lhal \ _
(1)2v
v
< 2. 1o
simplify nolalion, oonolo = (
1

1) ano 1 = (
1

1) = 2. so
lhal oqualion (10) Locomos:
(1 )( \((1

`)1 1)) ( \(

`1 1)) = 0.
1hal is,

`=
\1(1 ) \
(2 )1\
. (20)
=
\(
1

1)(1 ) (
1

1) \
(2 )(
1

1)\
.
2
1hal is,

` =
(
1

1)(1 )
v(

1)
(1)

(2 )(
1

1)
.
Nolo lhal, foi simplicily`s sako, wo solvoo lho maximizalion pioLlom
wilhoul imposing lho conoilion lhal lho piopoilion wilhoiawn fiom
Lank musl Lo loss lhan 1, ano wilhoul oxplicilly consiooiing lho non-
nogalivily of lho payol al limo 2 lhal agonls iocoivo fiom Lolh Lanks.
1hus, lho oplimal lovol of wilhoiawal fiom Lank is:
` = min
_
_
_
(
1

1)(1 )
v(

1)
(1)

(2 )(
1

1)
. 1
_
_
_
.
Nolo lhal if = 0.
` =
\(
1

1)(1 ) (
1

1) \
(2 )(
1

1)\
=
\(
1

1)
2(
1

1)\
=
1
2
.
which moans lhal if lho unoxpocloo iooomplion is low onough nol lo con-
lain any infoimalion on Lank , il will Lo mol Ly wilhoiawing oqually
fiom Lolh Lanks.
Nolo also lhal if = 1. lhon
` = min
_
1

1 \
(
1

1)\
. 1
_
= 1.
sinco
1
1
1
1
1 <
1
1
1
1
\ (iocall lhal \ < 2 ano
1
1
1
1
1). 1his moans
lhal if lho unoxpocloo iooomplion is so high lhal lho MMF knows lhal
lho ioluin on Lank assols is low, il will Lo mol Ly wilhoiawing fiom
Lank only.
Finally, nolo lhal fiom (20),
d
d
\1(1 ) \
(2 )1\
=
1
1\ ( 2)
2
(2 2\ 1\) =
1
1\ ( 2)
2
(2 \(2 1)) =
1
1\ ( 2)
2
(2 \) =

1\ ( 2)
2
(2 \) 0.
sinco \ < 2. 1hal is, lho highoi lho lovol of unoxpocloo iooomplions .
lho highoi lho piopoilion of funos wilhoiawn fiom Lank as opposoo
lo Lank 1 (sinco lho pioLaLilily lhal Lank has a low ioluin is highoi).
26
7.3 IrooI oI IroosItIon 1
Fiom lho assumplion :
0.v
1v
. wo know fiom (10) lhal c
1
= c
1
= 1.
1ho MMF iun conoilion (1) (14) Locomos:
(1 (: (1 :))) 0. +
_
(1 ) log(
c
1
2,
c
1
2,1
2
) log(
c
1
2,1
c
1
2,
2
) log(
c
1
2,1
c
1
2,
2
)
_
_(1 (: (1 :))) 0.
_
log(
c
1
2
1
2
) log(
c
1
2
1
2
)
_
.
Sinco
c
1
2,
. c
1
2,1
_c
1
2
= 1
1
c
1
2,
. c
1
2,1
_c
1
2
= 1
1
ano (1 (: (1 :))) _ 0 a foilioii il will Lo lhal:
(1 ) log(
1
1
1
1
2
) log(
1
1
1
1
2
) log(1
1
) _
log(
1
1
1
1
2
) log(
1
1
1
2
). (21)
Honco lho inoqualily (21) will holo il:
log(1
1
1
1
)
(2q)
log(21
1
)
q
_ log(1
1
1) log(1
1
1).
(1
1
1
1
)
(2q)
(21
1
)
q
_ (1
1
1)(1
1
1). (22)
Assumo lhal : =
1
2
j so lhal oiiocl lnanco may loao lo Lankiuplcy
foi high onough. Consiooi = 1 2j = 2:. so lhal foi lhis ioalizalion
of lhoio is no Lankiuplcy wilh oiiocl lnanco (howovoi small j is). Lol
us now show lhal Lankiuplcy will occui foi MMF inloimooialion foi j
small onough.
OLsoivo lhal foi = 1 lho inoqualily (22) Locomos
(1
1
1
1
)(21
1
) < (1
1
1)(1
1
1).
which is always salisloo foi any valuos of 1
1
ano 1
1
. sinco 1
1
< 1.
1hus Ly conlinuily, lhoio will a valuo of j. such lhal = 1 2j has
Lankiuplcy unooi MMF inloimooialion, Lul nol unooi oiiocl lnanco.
27
7.4 IrooI oI IroosItIon 2
Fiom lho pioof of Iioposilion 1 wo know lhal Lankiuplcy will occui if
(22) is salisloo. Ly algoLiaic manipulalion of (22) wo oLlain:
_ =
log
(1

1)(1

1)
(1

log
_
2
(

1)
_ . (28)
Nolo lhal Lolh lho oonominaloi ano lho numoialoi of lho IHS of (23)
aio nogalivo. 1ho oonominaloi is nogalivo sinco
2
(

1)
< 1. Il is oasy
lo show lhal lho numoialoi is also nogalivo. 1o soo lhal consiooi lhal
1 <
1
2
_
1
1
1
1
_
.
Ly conoilion (1) . 1hus:
1
2
_
1
1
1
_

1
2
_
1
1
1
_
<
_
1
1
1
1
_
.
which, Locauso of lho concavily of lho log funclion, yiolos
log
(1
1
1)(1
1
1)
(1
1
1
1
)
2
< 0.
1his also shows lhal lho IHS of (23) 0.
Wo also wanl lo sluoy lho sign of lho ooiivalivos of wilh iospocl
lo 1
1
ano 1
1
:
d
d1
1
=
1
1
1
1
2
1
1
_
ln

1
2
_
(1
1
1) (1
1
1)
0.
Fuilhoimoio, oonolo
` = log
(1
1
1)(1
1
1)
(1
1
1
1
)
2
ano 1 = log
_
21
1
1
1
1
1
_
.
1hon
J`
J1
1
=
(1
1
1
1
)
2
(1
1
1)(1
1
1)
_
(1
1
1)(1
1
1
1
)
2
2(1
1
1
1
)(1
1
1)
_
1
1
1
_
(1
1
1
1
)
1
_
=
1
(1
1
1)
_
1
1
1
1
2
1
1
1
1
_
< 0.
28
ano
J1
J1
1
=
1
1
1
1
1
< 0.
Honco
:iq:
J
J1
1
=:iq:
_
J`
J1
1
1
J1
J1
1
`
_
=
J`
J1
1
1
J1
J1
1
` =
_

_
<0
..
1
1
1
1
2
(1
1
1)(1
1
1
1
)
_

_
1
1
1
1
1
1
`.
Iocall lhal 1 < 0 ano ` < 0 ano lhal =
.
1
< 1. Honco [1[ [`[ .
1hus sumcionl conoilion foi
:iq:
_
J`
J1
1
1
J1
J1
1
`
_
0
is lhal

1
1
1
1
2
(1
1
1)(1
1
1
1
)

1
1
1
1
1
=

1
1
1
1
2
1
1
1

1
which is liuo sinco
1
1
1
1
2
1
1
1
= 1
1 1
1
1
1
1
< 1.
7.5 IrooI oI IroosItIon 3
Iocall lhal if :
0.v
1v
. lhon c
1
= 1. 1hoiofoio, lho conlagion conoilion
(17) Locomos
0 (1 (: (1 :)))
_
0. log
_
c
1
2,1
1
2
_
0. log
_
c
1
2,1
1
2
__
.
(24)
Wo know fiom conoilion (3) lhal
0
_
0. log
_
c
1
2,1
1
2
_
0. log
_
c
1
2,1
1
2
__
.
which onos lho pioof.
20