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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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Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 11-280.

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Date of creation: Nov 2011
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Publication status: Published in Journal of Financial Economics.
Handle: RePEc:tse:wpaper:25606

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  1. Stefano Giglio, 2011. "Credit default swap spreads and systemic financial risk," Proceedings 1122, Federal Reserve Bank of Chicago.
  2. 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.
  3. 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.
  4. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  5. Francis X. Diebold & Kamil Yilmaz, 2011. "On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms," Koç University-TUSIAD Economic Research Forum Working Papers, Koc University-TUSIAD Economic Research Forum 1124, Koc University-TUSIAD Economic Research Forum.
  6. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress Testing The Resilience Of Financial Networks," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1250006-1-1.
  7. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, Elsevier, vol. 102(3), pages 471-490.
  8. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
  9. Viral V Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? Asset-Backed Commercial Paper during the Financial Crisis of 2007–09," IMF Economic Review, Palgrave Macmillan, Palgrave Macmillan, vol. 58(1), pages 37-73, August.
  10. Jotikasthira, Chotibhak & Lundblad, Christian T. & Ramadorai, Tarun, 2009. "Asset fire sales and purchases and the international transmission of financial shocks," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7595, C.E.P.R. Discussion Papers.
  11. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  12. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  13. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1343-66, September.
  14. repec:fip:fedhpr:y:2010:i:may:p:65-71 is not listed on IDEAS
  15. Viral V. Acharya, 2010. "Measuring systemic risk," Proceedings 1140, Federal Reserve Bank of Chicago.
  16. 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, American Finance Association, vol. 68(3), pages 1179-1228, 06.
  17. Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, American Finance Association, vol. 66(4), pages 1141-1175, 08.
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Cited by:
  1. Ignacio Lozano & Alexander Guarín, 2014. "Fragilidad Bancaria en Colombia: Un Análisis Basado en las Hojas de Balance," Borradores de Economia 813, Banco de la Republica de Colombia.
  2. Ignacio Lozano & Alexander Guarín, 2014. "Banking Fragility in Colombia: An Empirical Analysis Based on Balance Sheets," BORRADORES DE ECONOMIA 011145, BANCO DE LA REPÚBLICA.
  3. Kristin Forbes, 2012. "The "Big C": Identifying Contagion," NBER Working Papers 18465, National Bureau of Economic Research, Inc.

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