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Vulnerable Banks

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  • Greenwood, Robin
  • Landier, Augustin
  • Thesmar, David

Abstract

When a bank experiences an adverse shock to its equity capital, one way to return to target leverage is to sell assets. The price impact of the fire sale may impact other institutions with common exposures, resulting in contagion. We propose a simple framework that accounts for this effect. This framework explains how the distribution of leverage and risk exposures across banks contributes to systemic risk. We use it to compute a bank's exposure to sector-wide deleveraging, as well as the spillover of a bank's deleveraging onto other banks. We explain how the model can be used to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. We then apply the framework to measure (a) the vulnerability of European banks to sovereign risk in 2010 and 2011, and (b) the vulnerability of US financial institutions between 2001 and 2010. In our model, \microprudential" interventions, which target the solvency of individual banks are always less effective than \macroprudential", policies which aim to minimize spillovers across firms.

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Bibliographic Info

Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 700.

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Date of creation: Nov 2011
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Handle: RePEc:ide:wpaper:25524

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References

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  1. Francis X. Diebold & Kamil Yilmaz, 2011. "On the network topology of variance decompositions: Measuring the connectedness of financial firms," Working Papers 11-45, Federal Reserve Bank of Philadelphia.
  2. Sebnem Kalemli-Ozcan & Elias Papaioannou & José-Luis Peydró, 2013. "Financial Regulation, Financial Globalization, and the Synchronization of Economic Activity," Journal of Finance, American Finance Association, vol. 68(3), pages 1179-1228, 06.
  3. repec:fip:fedhpr:y:2010:i:may:p:65-71 is not listed on IDEAS
  4. Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, vol. 66(4), pages 1141-1175, 08.
  5. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
  6. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," Economics Working Papers ECO2010/26, European University Institute.
  7. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
  8. Allen, Franklin & Babus, Ana & Carletti, Elena, 2013. "Asset Commonality, Debt Maturity and Systemic Risk," Working Papers 10-30, University of Pennsylvania, Wharton School, Weiss Center.
  9. Jotikasthira, Chotibhak & Lundblad, Christian T. & Ramadorai, Tarun, 2009. "Asset fire sales and purchases and the international transmission of financial shocks," CEPR Discussion Papers 7595, C.E.P.R. Discussion Papers.
  10. Stefano Giglio, 2011. "Credit default swap spreads and systemic financial risk," Proceedings 1122, Federal Reserve Bank of Chicago.
  11. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  12. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  13. Viral V. Acharya, 2010. "Measuring systemic risk," Proceedings 1140, Federal Reserve Bank of Chicago.
  14. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
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Cited by:
  1. Ignacio Lozano & Alexander Guarín, 2014. "Banking Fragility in Colombia: An Empirical Analysis Based on Balance Sheets," Borradores de Economia 813, Banco de la Republica de Colombia.

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