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A Network Model of Super-systemic Crises

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  • Prasanna Gai
  • Sujit Kapadia
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    Abstract

    Although the financial systems of advanced countries have weathered numerous shocks in recent years, the events triggered by the sub-prime crisis of August 2007 have been “super-systemic” in scope, enveloping financial institutions across the major economies as well as far away Iceland and New Zealand. In this paper, we apply network techniques to develop a framework for analyzing financial contagion that isolate the probability of contagion from its potential spread. Our results suggest that complex financial systems may be robust-yet-fragile in nature. Under plausible assumptions, the greater connectivity implied by new financial instruments (e.g., credit derivatives) reduces the likelihood of contagion. But the impact on the financial system, in the event of problems, can be on a significantly larger scale than before.

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    Bibliographic Info

    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 542.

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    Date of creation: Dec 2009
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    Handle: RePEc:chb:bcchwp:542

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    1. Hyun Song Shin, 2006. "Risk and liquidity in a system context," BIS Working Papers 212, Bank for International Settlements.
    2. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers 79, Oesterreichische Nationalbank (Austrian Central Bank).
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    11. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
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    13. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
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    16. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
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