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Unformatted text preview: takes on added importance for both contagion and ampliﬁcation once we
introduce bankruptcy costs and mark-to-market reductions in credit quality. Bankruptcy costs steepen
the losses at defaulted nodes, thereby increasing the likelihood that defaults will spread to other nodes.
These losses are further ampliﬁed by feedback eﬀects, thus increasing the system-wide loss in value. By
contrast, reductions in credit quality have the eﬀect of marking down asset values in advance of default.
This process is akin to a slippery slope: once some node suﬀers a deterioration in its balance sheet,
its mark-to-market value decreases, which reduces the value of the nodes to which it has obligations,
causing their balance sheets to deteriorate. The result can be a system-wide reduction in value that was
triggered solely by a loss of conﬁdence rather than an actual default. References
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This document was uploaded on 02/20/2014 for the course ECON 101 at Pontificia Universidad Católica de Chile.
- Spring '11