IDEAS home Printed from
MyIDEAS: Login to save this article or follow this journal

The Asymmetric Effect of Diffusion Processes: Risk Sharing and Contagion

  • Gallegati Mauro


    (Università Politecnica delle Marche)

  • Greenwald Bruce


    (Columbia University)

  • Richiardi Matteo G


    (Università Politecnica delle Marche and Collegio Carlo Alberto - LABORatorio R. Revelli)

  • Stiglitz Joseph E.


    (Columbia University)

In this paper we provide a general characterization of diffusion processes, allowing us to analyze both risk-sharing and contagion effects at the same time.We illustrate the relevance of our theory with reference to the subprime mortgage crisis and more in general to the processes of securitization and interbank linkages. We show that interdependencies in real and financial assets are beneficial from a social point of view when the economic environment is favorable and detrimental when the economic environment deteriorates. In the latter case, private incentives are such that too many linkages are formed, with respect to what is socially desirable. The risk of contagion increases the volatility of the outcome and thus reduces the ability of the financial networks to provide risk-sharing.Our analysis suggests that a likely major explanation of the subprime mortgage crisis is the process of securitization itself, in addition to the absence of transparency about the characteristics of the underlying assets that the multiple layers of financial intermediation fostered, as commonly claimed.This may call for a different emphasis on the role of public intervention. While a goal to stabilize the economy in good times should be to disrupt the channels that bring contagion, that is a positive correlation in the returns, in a period of worsening economic conditions our analysis suggests regulatory intervention aimed at disconnecting the economy at crucial nodes. Moreover, we show that policy interventions should be aimed at rescuing institutions, but not their managers. Diminishing the cost of default actually increases the inefficiency due to the divergence between the social and the individual optimum.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: For access to full text, subscription to the journal or payment for the individual article is required.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by De Gruyter in its journal Global Economy Journal.

Volume (Year): 8 (2008)
Issue (Month): 3 (September)
Pages: 1-22

in new window

Handle: RePEc:bpj:glecon:v:8:y:2008:i:3:n:2
Contact details of provider: Web page:

Order Information: Web:

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:bpj:glecon:v:8:y:2008:i:3:n:2. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peter Golla)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.