Bankruptcy Codes and Risk Sharing of Currency Unions

48 Pages Posted: 11 Nov 2019 Last revised: 16 Feb 2021

See all articles by Xuan Wang

Xuan Wang

VU University Amsterdam; Tinbergen Institute

Date Written: November 4, 2019

Abstract

Since the Eurozone Crisis of 2010-12, a critical debate on the viability of a currency union has focused on the role of a fiscal union in adjusting for country heterogeneity. However, a fully-fledged fiscal union may not be politically feasible. This paper develops a two-country general equilibrium model to examine the benefits of the bankruptcy code of a capital markets union - in the absence of a fiscal union - as an alternative mechanism to improve the financial stability and welfare of a currency union. When domestic credit risks are present, I show that a lenient bankruptcy code in the cross-border capital markets union removes the pecuniary externality of banking insolvency, so it leads to a Pareto improvement within the currency union. Moreover, the absence of floating nominal exchange rates removes a mechanism to neutralise domestic credit risks; I show that softening the bankruptcy code can recoup the lost benefits of floating nominal exchange rates. The model provides the financial stability and welfare implications of bankruptcy within a capital markets union in the Eurozone.

Keywords: default, bankruptcy code, fiscal union, capital markets union, financial stability, bank credit, inside money, price-level and exchange rate determinacy, liquidity intermediary asset pricing

JEL Classification: E42, F33, G15, G21

Suggested Citation

Wang, Xuan, Bankruptcy Codes and Risk Sharing of Currency Unions (November 4, 2019). Saïd Business School WP 2019-15, Available at SSRN: https://ssrn.com/abstract=3481719 or http://dx.doi.org/10.2139/ssrn.3481719

Xuan Wang (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

HOME PAGE: http://https://sites.google.com/view/xuan-wang

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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