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Systemic Risk in Financial Systems

Author

Listed:
  • Larry Eisenberg

    () (The Risk Engineering Company, 1376 Midland Avenue, No. 603, Bronxville, New York 10708-6853)

  • Thomas H. Noe

    () (A. B. Freeman School of Business, Goldring/Woldenberg Hall, Tulane University, New Orleans, Louisiana 70118-5669)

Abstract

We consider default by firms that are part of a single clearing mechanism. The obligations of all firms within the system are determined simultaneously in a fashion consistent with the priority of debt claims and the limited liability of equity. We first show, via a fixed-point argument, that there always exists a "clearing payment vector" that clears the obligations of the members of the clearing system; under mild regularity conditions, this clearing vector is unique. Next, we develop an algorithm that both clears the financial system in a computationally efficient fashion and provides information on the systemic risk faced by the individual system firms. Finally, we produce qualitative comparative statics for financial systems. These comparative statics imply that, in contrast to single-firm results, even unsystematic, nondissipative shocks to the system will lower the total value of the system and may lower the value of the equity of some of the individual system firms.

Suggested Citation

  • Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  • Handle: RePEc:inm:ormnsc:v:47:y:2001:i:2:p:236-249
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    File URL: http://dx.doi.org/10.1287/mnsc.47.2.236.9835
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    References listed on IDEAS

    as
    1. Milgrom, Paul & Roberts, John, 1994. "Comparing Equilibria," American Economic Review, American Economic Association, vol. 84(3), pages 441-459, June.
    2. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-762, November.
    3. Angelini, P. & Maresca, G. & Russo, D., 1996. "Systemic risk in the netting system," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 853-868, June.
    4. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
    5. Brown, David T, 1989. "Claimholder Incentive Conflicts in Reorganization: The Role of Bankruptcy Law," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 109-123.
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    Keywords

    Credit Risk; Default; Clearing Systems;

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