Financial Connections and Systemic Risk

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dc.contributor.author ALLEN, Franklin
dc.contributor.author BABUS, Ana
dc.contributor.author CARLETTI, Elena
dc.date.accessioned 2010-05-25T08:47:01Z
dc.date.available 2010-05-25T08:47:01Z
dc.date.issued 2010
dc.identifier.issn 1725-6704
dc.identifier.uri http://hdl.handle.net/1814/14059
dc.description.abstract An important source of systemic risk is overlapping portfolio exposures among financial institutions. We develop a model where institutions form connections through swaps of projects in order to diversify their individual risk. These connections lead to two different network structures. In a clustered network groups of financial institutions within a cluster hold identical portfolios. Defaults occur together but the number of states where this happens is small. In an unclustered network defaults are more dispersed but they occur in more states. With long term finance there is no difference between the two structures in terms of total defaults and welfare. In contrast, when short term finance is used, the network structure matters. Upon the arrival of a signal about banks’ future defaults, investors update their expectations of the ability of financial institutions to repay them. If their updated expectations are low, they do not to roll over the debt and there is systemic risk in that all institutions are early liquidated. We compare the clustered and unclustered networks and analyze which is better in welfare terms en
dc.language.iso en en
dc.relation.ispartofseries EUI ECO en
dc.relation.ispartofseries 2010/26 en
dc.title Financial Connections and Systemic Risk en
dc.type Working Paper en
dc.neeo.contributor ALLEN|Franklin|aut|
dc.neeo.contributor BABUS|Ana|aut|
dc.neeo.contributor CARLETTI|Elena|aut|EUI70001
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