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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. Sanjeev Goyal & Andrea Galeotti, 2007. "A Theory of Strategic Diffusion," Working Papers 2007.70, Fondazione Eni Enrico Mattei.
  2. Lelyveld, Iman van & Liedorp, Franka, 2006. "Interbank Contagion in the Dutch Banking Sector: A Sensitivity Analysis," MPRA Paper 806, University Library of Munich, Germany.
  3. X. Freixas & B. Parigi & J-C. Rochet, 2000. "Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank," DNB Staff Reports (discontinued) 47, Netherlands Central Bank.
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  9. Shin, Hyun Song, 2008. "Risk and liquidity in a system context," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 315-329, July.
  10. Lelyveld, Iman van & Liedorp, Franka, 2004. "Interbank Contagion in the Dutch Banking Sector," MPRA Paper 651, University Library of Munich, Germany, revised 11 Jul 2005.
  11. Jackson, Matthew O. & Yariv, Leeat, 2006. "Diffusion of Behavior and Equilibrium Properties in Network Games," Working Papers 1264, California Institute of Technology, Division of the Humanities and Social Sciences.
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  13. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
  14. 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.
  15. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, vol. 52(9), pages 1301-1314, September.
  16. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
  17. 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.
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