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Heterogeneity and Stability: Bolster the Strong, Not the Weak

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  • Dong Beom Choi

Abstract

We first study a stylized model of self-fulfilling panic among agents with differing fragilities to strategic risk and show that depending on the severity of coordination problems, the panic trigger threshold can depend only on one type's fragility. We then present a model of systemic panic among financial institutions with heterogeneous fragilities to financial spillovers. Concerns about potential spillovers generate strategic interaction, triggering a pre-emption game in which one tries to exit the market before others to avoid spillovers. Although financial contagion originates in weaker institutions, systemic risk can critically depend on financial health of stronger in the contagion chain. In this case, bolstering the strong, rather than the weak, more effectively enhances systemic stability.

Suggested Citation

  • Dong Beom Choi, 2014. "Heterogeneity and Stability: Bolster the Strong, Not the Weak," Review of Financial Studies, Society for Financial Studies, vol. 27(6), pages 1830-1867.
  • Handle: RePEc:oup:rfinst:v:27:y:2014:i:6:p:1830-1867.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu023
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    Cited by:

    1. Allen, Franklin & Carletti, Elena & Goldstein, Itay & Leonello, Agnese, 2018. "Government guarantees and financial stability," Journal of Economic Theory, Elsevier, vol. 177(C), pages 518-557.
    2. repec:eee:finsta:v:41:y:2019:i:c:p:55-72 is not listed on IDEAS
    3. Roman, Raluca & Berger, Allen N. & Sedunov, John, 2016. "Do bank bailouts reduce or increase systemic risk? the effects of TARP on financial system stability," Research Working Paper RWP 16-8, Federal Reserve Bank of Kansas City.
    4. Guimaraes, Bernardo & Pereira, Ana Elisa, 2017. "Dynamic coordination among heterogeneous agents," Journal of Mathematical Economics, Elsevier, vol. 73(C), pages 13-33.
    5. repec:eee:finsta:v:39:y:2018:i:c:p:125-132 is not listed on IDEAS
    6. repec:wsi:qjfxxx:v:08:y:2018:i:02:n:s2010139218500118 is not listed on IDEAS
    7. Silva, Walmir & Kimura, Herbert & Sobreiro, Vinicius Amorim, 2017. "An analysis of the literature on systemic financial risk: A survey," Journal of Financial Stability, Elsevier, vol. 28(C), pages 91-114.

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    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G01 - Financial Economics - - General - - - Financial Crises

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