OFRwp0009_GlassermanYoung_HowLikelyContagionFinancialNetworks

Working paper belgian national bank 12 demange g 2012

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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 [1] Acemoglu, D., Ozdaglar, A., and Tahbaz-Salehi, A. (2013). Systemic Risk and Stability in Financial Networks. Working Paper 18727, National Bureau of Economic Research, Cambridge, Massachusetts. [2] Allen, F., and Babus, A. (2009). Networks in Finance. In The Network Challenge: Strategy, Profit, and Risk in an Interlinked World (eds. P. Kleindorfer, Y. Wind & R. Gunther), Wharton School Publishing, Upper Saddle River, New Jersey. [3] Allen, F., and Carletti, E. (2011). New Theories to Underpin Financial Reform, Journal of Financial Stability, in press. [4] Allen, F., and Gale, G. (2000). Financial Contagion, Journal of Political Economy 108 1–33. 28 [5] Bank of England (2011). Financial Stability Report 29. Available at www.bankofengland.co.uk. [6] Barlow, R.E., and Proschan, F. (1975). Statistical Theory of Reliability and Life Testing, Holt, Rinehart, and Winston, New York. [7] Battiston, S., Delli Gatti, D., Gallegati, M., Greenwald, B., and Stiglitz, J.E. (2012). Default Cascades: When Does Risk Diversification Increase Stability? Journal of Financial Stability 8, 138-149. [8] Caccioli, F., Shrestha, M., Moore, C., and Farmer, J.D. (2012). Stability Analysis of Financial Contagion Due to Overlapping Portfolios. Working Paper 2012-10-018, Santa Fe Institute. [9] Cifuentes, R., Ferrucci, G., and Shin, H.S. (2005). Liquidity Risk and Contagion, Journal of the European Economic Association 3, 556–566. [10] Cont, R., Moussa, A., and Santos, E. (2010). Network Structure and Systemic Risk in Banking Systems. Available at SSRN: http://ssrn.com/abstract=1733528. [11] Degryse, H., and Nguyen, G. (2004). Interbank Exposures: An Empirical Examination of Systemic Risk in the Belgian Banking System. Working paper, Belgian National Bank. [12] Demange, G. (2012). Contagion in Financial Networks: A Threat Index. Working Paper 2012-02, Paris School of Economics, Paris. [13] Diamond, D.W., and Dybvig, P. (1983). Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy 91, 401–419. [14] Eisenberg, L., and Noe, T.H. (2001). Systemic Risk in Financial Systems,...
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This document was uploaded on 02/20/2014 for the course ECON 101 at Pontificia Universidad Católica de Chile.

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