Financial Contagion in a Two‐Country Model.

This paper studies a two‐country version of the standard banking model with financial markets to investigate the effects of financial market globalization on financial stability. In autarky, two types of banks arise endogenously: some always remain solvent and others can default. When the financial markets are integrated, three types of banks can arise endogenously, and some banks go bankrupt because of the liquidity shock of another country. I show that financial market globalization can cause financial contagion and reduce welfare. In addition, the endogenous heterogeneous risk profile of the two countries can be observed. [ABSTRACT FROM AUTHOR]