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Default risk in an interconnected banking system with endogeneous asset markets

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  • Bluhm, Marcel
  • Krahnen, Jan Pieter

Abstract

This paper analyzes the emergence of systemic risk in a network model of interconnected bank balance sheets. Given a shock to asset values of one or several banks, systemic risk in the form of multiple bank defaults depends on the strength of balance sheets and asset market liquidity. The price of bank assets on the secondary market is endogenous in the model, thereby relating funding liquidity to expected solvency - an important stylized fact of banking crises. Based on the concept of a system value at risk, Shapley values are used to define the systemic risk charge levied upon individual banks. Using a parallelized simulated annealing algorithm the properties of an optimal charge are derived. Among other things we find that there is not necessarily a correspondence between a bank's contribution to systemic risk - which determines its risk charge - and the capital that is optimally injected into it to make the financial system more resilient to systemic risk. The analysis has policy implications for the design of optimal bank levies. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2011/19.

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Date of creation: 2011
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Handle: RePEc:zbw:cfswop:201119

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Related research

Keywords: Systemic Risk; Systemic Risk Charge; Systemic Risk Fund; Macroprudential Supervision; Shapley Value; Financial Network;

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References

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  1. Gary B. Gorton, 2009. "Information, Liquidity, and the (Ongoing) Panic of 2007," NBER Working Papers 14649, National Bureau of Economic Research, Inc.
  2. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
  3. Gunnar Bardsen & Kjersti-Gro Lindquist & Dimitrios P.Tsomocos, 2006. "Evaluation of macroeconomic models for financial stability analysis," OFRC Working Papers Series, Oxford Financial Research Centre 2006fe01, Oxford Financial Research Centre.
  4. Claudio Borio, 2008. "The financial turmoil of 2007-?: a preliminary assessment and some policy considerations," BIS Working Papers 251, Bank for International Settlements.
  5. Lehar, Alfred, 2005. "Measuring systemic risk: A risk management approach," Journal of Banking & Finance, Elsevier, Elsevier, vol. 29(10), pages 2577-2603, October.
  6. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 79, Oesterreichische Nationalbank (Austrian Central Bank).
  7. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper, Tilburg University, Center for Economic Research 2007-100, Tilburg University, Center for Economic Research.
  8. Juan Sole & Marco A Espinosa-Vega, 2010. "Cross-Border Financial Surveillance," IMF Working Papers 10/105, International Monetary Fund.
  9. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 23(1), pages 77-100, Winter.
  10. Aikman, David & Alessandri, Piergiorgio & Eklund, Bruno & Gai, Prasanna & Kapadia, Sujit & Martin, Elizabeth & Mora, Nada & Sterne, Gabriel & Willison, Matthew, 2009. "Funding liquidity risk in a quantitative model of systemic stability," Bank of England working papers, Bank of England 372, Bank of England.
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Cited by:
  1. Krahnen, Jan Pieter, 2013. "Rescue by regulation? Key points of the Liikanen report," SAFE White Paper Series 9, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  2. Christian Weistroffer, 2011. "Identifying Systemically Important Financial Institutions (SIFIs)," Working Papers id:4383, eSocialSciences.

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