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Financial Networks and Contagion

Author

Listed:
  • Matthew Elliott
  • Benjamin Golub
  • Matthew O. Jackson

Abstract

We study cascades of failures in a network of interdependent financial organizations: how discontinuous changes in asset values (e.g., defaults and shutdowns) trigger further failures, and how this depends on network structure. Integration (greater dependence on counterparties) and diversification (more counterparties per organization) have different, nonmonotonic effects on the extent of cascades. Diversification connects the network initially, permitting cascades to travel; but as it increases further, organizations are better insured against one another's failures. Integration also faces trade-offs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate the model with data on European debt cross-holdings.

Suggested Citation

  • Matthew Elliott & Benjamin Golub & Matthew O. Jackson, 2014. "Financial Networks and Contagion," American Economic Review, American Economic Association, vol. 104(10), pages 3115-3153, October.
    • Handle: RePEc:aea:aecrev:v:104:y:2014:i:10:p:3115-53
    Note: DOI: 10.1257/aer.104.10.3115
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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