Endogenous Response to the ‘Network Tax’
AbstractThe turmoil in the financial markets that had its roots in the 2007 US subprime crisis prompted government action all over the world motivated by contagion concerns, leaving a heavy bill for the tax payers to pick up. We find that a contributory regime based on contagion risk exposure changes the trade-off between liquidity coinsurance and counterparty risk that motivates the formation of the financial network in the first place, potentially leading to a less connected architecture. Furthermore, if that regime bestows the weight of the levy on both borrower and lender it has the potential to shift the system towards safer grounds. Since we model bank interactions as a network formation game, we are able to provide an account of the changes that come into play with the introduction of tax, which can be a fundamental factor in the design process of the policy function.
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Bibliographic InfoPaper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 408.
Length: 26 pages
Date of creation: Mar 2011
Date of revision:
Financial Network; Regulation; Counterparty Risk; Liquidity Coinsurance;
Find related papers by JEL classification:
- D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-26 (All new papers)
- NEP-BAN-2011-03-26 (Banking)
- NEP-NET-2011-03-26 (Network Economics)
- NEP-PKE-2011-03-26 (Post Keynesian Economics)
- NEP-REG-2011-03-26 (Regulation)
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