# Reduction of systemic risk by means of Pigouvian taxation

## Author Info

• Vinko Zlati\'c
• Giampaolo Gabbi
• Hrvoje Abraham

## Abstract

We analyze the possibility of reduction of systemic risk in financial markets through Pigouvian taxation of financial institutions which is used to support the rescue fund. We introduce the concept of the cascade risk with a clear operational definition as a subclass and a network related measure of the systemic risk. Using financial networks constructed from real Italian money market data and using realistic parameters, we show that the cascade risk can be substantially reduced by a small rate of taxation and by means of a simple strategy of the money transfer from the rescue fund to interbanking market subjects. Furthermore, we show that while negative effects on the return on investment ($ROI$) are direct and certain, an overall positive effect on risk adjusted return on investments ($ROI^{RA}$) is visible. Please note that \emph{the taxation} is introduced as a monetary/regulatory, not as a fiscal measure, as the term could suggest. \emph{The rescue fund} is implemented in a form of a common reserve fund.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://arxiv.org/pdf/1406.5817

## Bibliographic Info

Paper provided by arXiv.org in its series Papers with number 1406.5817.

as
in new window

## References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
1. 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.
2. Iori, Giulia & Jafarey, Saqib & Padilla, Francisco G., 2006. "Systemic risk on the interbank market," Journal of Economic Behavior & Organization, Elsevier, vol. 61(4), pages 525-542, December.
3. Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
4. Thakor, Anjan V, 1996. " Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 51(1), pages 279-324, March.
5. Oliver Hart & Luigi Zingales, 2011. "A New Capital Regulation for Large Financial Institutions," American Law and Economics Review, Oxford University Press, vol. 13(2), pages 453-490.
6. 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.
7. Stefano Battiston & Domenico Delli Gatti & Mauro Gallegati & Bruce Greenwald & Joseph E. Stiglitz, "undated". "Default Cascades: When Does Risk Diversification Increase Stability?," Working Papers ETH-RC-11-006, ETH Zurich, Chair of Systems Design.
8. Zsolt Darvas & Jakob von Weizsäcker, 2010. "Financial-Transaction Tax: Small Is Beautiful," Policy Contributions 379, Bruegel.
9. Iori, G. & Masi, G. D. & Precup, O. V. & Gabbi, G. & Caldarelli, G., 2005. "A network analysis of the Italian oversight money market," Working Papers 05/05, Department of Economics, City University London.
10. Karl Whelan, 2009. "Containing systemic risk," Working Papers 200927, School of Economics, University College Dublin.
11. V. Zlatic & G. Bianconi & A. Díaz-Guilera & D. Garlaschelli & F. Rao & G. Caldarelli, 2009. "On the rich-club effect in dense and weighted networks," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 67(3), pages 271-275, February.
12. Finger, Karl & Fricke, Daniel & Lux, Thomas, 2012. "Network analysis of the e-MID overnight money market: The informational value of different aggregation levels for intrinsic dynamic processes," Kiel Working Papers 1782, Kiel Institute for the World Economy (IfW).
13. Gauthier, Céline & Lehar, Alfred & Souissi, Moez, 2012. "Macroprudential capital requirements and systemic risk," Journal of Financial Intermediation, Elsevier, vol. 21(4), pages 594-618.
14. Stefano Battiston & Domenico Delli Gatti & Mauro Gallegati & Bruce C. Greenwald & Joseph E. Stiglitz, 2009. "Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk," NBER Working Papers 15611, National Bureau of Economic Research, Inc.
15. Thomas Lux, Daniel Fricke, 2012. "Core-Periphery Structure in the Overnight Money Market: Evidence from the e-MID Trading Platform," Kiel Working Papers 1759, Kiel Institute for the World Economy.
16. Martin Hellwig, 2010. "Capital Regulation after the Crisis: Business as Usual?," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2010_31, Max Planck Institute for Research on Collective Goods.
17. Dorothea Schäfer & Stephan Schulmeister & John Vella & Donato Masciandaro & Francesco Passarelli & Ross Buckley, 2012. "The financial transaction tax — Boon or bane?," Intereconomics: Review of European Economic Policy, Springer;German National Library of Economics;Centre for European Policy Studies (CEPS), vol. 47(2), pages 76-103, March.
18. Raddant, Matthias, 2012. "Structure in the Italian overnight loan market," Kiel Working Papers 1772, Kiel Institute for the World Economy (IfW).
19. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
20. Drehmann, Mathias & Tarashev, Nikola, 2013. "Measuring the systemic importance of interconnected banks," Journal of Financial Intermediation, Elsevier, vol. 22(4), pages 586-607.
21. repec:cty:dpaper:13/14 is not listed on IDEAS
22. Schlüter, Tobias & Busch, Ramona & Hartmann-Wendels, Thomas & Sievers, Sönke, 2012. "Determinants of the interest rate pass-through of banks: Evidence from German loan products," Discussion Papers 26/2012, Deutsche Bundesbank, Research Centre.
23. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "Network topology of the interbank market," Quantitative Finance, Taylor & Francis Journals, vol. 4(6), pages 677-684.
24. Itai Agur, 2010. "Capital Requirements and Credit Rationing," DNB Working Papers 257, Netherlands Central Bank, Research Department.
Full references (including those not matched with items on IDEAS)

## Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

## Corrections

When requesting a correction, please mention this item's handle: RePEc:arx:papers:1406.5817. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.