Three Branches of Theories of Financial Crises

In this paper, we review three branches of theoretical literature on financial crises. The first one deals with banking crises originating from coordination failures among bank creditors. The second one deals with frictions in credit and interbank markets due to problems of moral hazard and adverse selection. The third one deals with currency crises. We discuss the evolutions of these branches of the literature and how they have been integrated recently to explain the turmoil in the world economy around the East Asian Crises and in the last few years. We discuss the relation of the models to the empirical evidence and their ability to guide policies to avoid or mitigate future crises. 1 University of Pennsylvania The Wharton School Finance Department , The Wharton School, 3620 Locust Walk, Philadelphia, PA 19104, United States. Email: [email protected]. 2 Cornell University, Uris Hall, 4th Floor, Ithaca, NY 14853, United States. Email: [email protected]. 2