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A Network Model of Super-Systemic Crises

In: Financial Stability, Monetary Policy, and Central Banking

  • Prasanna Gai

    (Australian National University and Bank of England)

  • Sujit Kapadia
  • Bank of England

Although the financial systems of advanced countries have weathered numerous shocks in recent years, the events triggered by the sub-prime crisis of August 2007 have been “super-systemic” in scope, enveloping financial institutions across the major economies as well as far away Iceland and New Zealand. In this paper, we apply network techniques to develop a framework for analyzing financial contagion that isolate the probability of contagion from its potential spread. Our results suggest that complex financial systems may be robust-yet-fragile in nature. Under plausible assumptions, the greater connectivity implied by new financial instruments (e.g., credit derivatives) reduces the likelihood of contagion. But the impact on the financial system, in the event of problems, can be on a significantly larger scale than before.

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This chapter was published in: Rodrigo Alfaro (ed.) Financial Stability, Monetary Policy, and Central Banking, , chapter 13, pages 411-432, 2011.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v15c13pp411-432.
Handle: RePEc:chb:bcchsb:v15c13pp411-432
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  1. Iman van Lelyveld & Franka Liedorp, 2004. "Interbank Contagion in the Dutch Banking Sector," DNB Working Papers 005, Netherlands Central Bank, Research Department.
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  8. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-38, August.
  9. Hyun Song Shin, 2006. "Risk and liquidity in a system context," BIS Working Papers 212, Bank for International Settlements.
  10. Iman van Lelyveld & Franka Liedorp, 2006. "Interbank Contagion in the Dutch Banking Sector: A Sensitivity Analysis," International Journal of Central Banking, International Journal of Central Banking, vol. 2(2), May.
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  13. Isabel Schnabel & Hyun Song Shin, 2004. "Liquidity and Contagion: The Crisis of 1763," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 929-968, December.
  14. Furfine, Craig H, 2003. " Interbank Exposures: Quantifying the Risk of Contagion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 111-28, February.
  15. Paolo Emilio Mistrulli, 2007. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Temi di discussione (Economic working papers) 641, Bank of Italy, Economic Research and International Relations Area.
  16. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers 79, Oesterreichische Nationalbank (Austrian Central Bank).
  17. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
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