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Financial networks: contagion, commitment, and private sector bailouts

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  • Yaron Leitner

Abstract

The author develops a model of financial networks where linkages not only spread contagion, but also induce private-sector bailouts in which liquid banks bail out illiquid banks because of the threat of contagion. Introducing this bailout possibility, the author shows that linkages may be optimal ex-ante because they allow banks to obtain some mutual insurance even though formal commitments are impossible. However, in some cases (for example, when liquidity is concentrated among a small group of banks), the whole network may collapse. The author also characterizes the optimal network size and apply the results to joint liability arrangements and payment systems.> Original working paper title: Fragile financial networks.

Suggested Citation

  • Yaron Leitner, 2004. "Financial networks: contagion, commitment, and private sector bailouts," Working Papers 02-9, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:02-9
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    References listed on IDEAS

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    Cited by:

    1. Lippert, Steffen & Spagnolo, Giancarlo, 2011. "Networks of relations and Word-of-Mouth Communication," Games and Economic Behavior, Elsevier, vol. 72(1), pages 202-217, May.
    2. Spagnolo, Giancarlo & Lippert, Steffen, 2004. "Networks of Relations," SSE/EFI Working Paper Series in Economics and Finance 570, Stockholm School of Economics, revised 04 Jun 2010.

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