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Forward-looking solvency contagion

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  • Bardoscia, Marco
  • Barucca, Paolo
  • Codd, Adam Brinley
  • Hill, John

Abstract

Solvency contagion risk is a key channel through which systemic risk can come about. We introduce a model that accounts not only for losses transmitted after banks default, but also for losses due to the fact that creditors revalue their exposures when probabilities of default of their counterparties change. We apply the model to run a series of simplified stress tests of the UK banking system from 2008 to 2016, based on two datasets of real interbank exposures between the seven major UK banks. We show that risks due to solvency contagion decrease markedly from the peak of the crisis, to the point of becoming negligible. We also characterise the distributions of both vulnerabilities and systemic importances of individual banks, thereby tracking the evolution of risk concentration.

Suggested Citation

  • Bardoscia, Marco & Barucca, Paolo & Codd, Adam Brinley & Hill, John, 2019. "Forward-looking solvency contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
  • Handle: RePEc:eee:dyncon:v:108:y:2019:i:c:s0165188919301526
    DOI: 10.1016/j.jedc.2019.103755
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    References listed on IDEAS

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    Cited by:

    1. Abduraimova, Kumushoy & Nahai-Williamson, Paul, 2021. "Solvency distress contagion risk: network structure, bank heterogeneity and systemic resilience," Bank of England working papers 909, Bank of England.
    2. Marco Bardoscia & Paolo Barucca & Stefano Battiston & Fabio Caccioli & Giulio Cimini & Diego Garlaschelli & Fabio Saracco & Tiziano Squartini & Guido Caldarelli, 2021. "The Physics of Financial Networks," Papers 2103.05623, arXiv.org.

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    More about this item

    Keywords

    Financial networks; Systemic risk; Financial contagion; Macro-prudential policy; Stress testing;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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