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Network externalities across financial institutions

Author

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  • Carlos Castro

    ()

  • Juan S. Ordoñez

    ()

  • Sergio Preciado

    ()

Abstract

We propose and estimate a financial distress model that explicitly accounts for the interactions or spill-over effects between financial institutions, through the use of a spatial continuity matrix that is build from financial network data of interbank transactions. Such setup of the financial distress model allows for the empirical validation of the importance of network externalities in determining financial distress, in addition to institution specific and macroeconomic covariates. The relevance of such specification is that it incorporates simultaneously micro-prudential factors (Basel 2) as well as macro-prudential and systemic factors (Basel 3) as determinants of financial distress. Results indicate network externalities are an important determinant of financial health of a financial institutions. The parameter that measures the effect of network externalities is both economically and statistical significant and its inclusion as a risk factor reduces the importance of the firm specific variables such as the size or degree of leverage of the financial institution. In addition we analyse the policy implications of the network factor model for capital requirements and deposit insurance pricing.

Suggested Citation

  • Carlos Castro & Juan S. Ordoñez & Sergio Preciado, 2016. "Network externalities across financial institutions," Documentos de Trabajo 014287, Universidad del Rosario.
  • Handle: RePEc:col:000092:014287
    as

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    File URL: http://repository.urosario.edu.co/bitstream/handle/10336/11752/dt184.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    systemic risk; network models; spatial econometrics;
    All these keywords.

    JEL classification:

    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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