Contagion in Financial Networks: A Threat Index
Interbank claims are a concern to regulators as they might facilitate the dissemination of defaults and generate spill-over effects. Building on a simple model, this paper introduces a measure of the spill-over effects that a bank generates when it defaults. The measure is based on an explicit criterion, the aggregate debt repayments, and is bankâ€™s specific, affected by the bankâ€™s characteristics and links to other banks. Such measure can be useful to a regulator to determine in which banks cash should be injected during a default episode or to evaluate the impact of raising capital before the occurrence of default. The approach applies more generally to a system of entities that are linked through financial claims. This is illustrated to evaluate the consolidated foreign claims of 10 EU countries.
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