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Do Financial Markets Expect Bank Defaults to be Contagious?

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  • Mark Mink

Abstract

Simultaneous bank defaults are often attributed to interbank contagion, but can also be due to common shocks affecting banks with similar balance sheets. We disentangle both effects by realising that if financial markets expect a bank's default to be contagious, an increase in this bank's default probability should lower other banks' market valuations. When we regress changes in banks' market values on changes in other banks' default probabilities for the 2007-2009 financial crisis, we find no evidence for such an effect. This finding suggests that contagion risk has been overestimated, which has implications for financial regulation and crisis management.

Suggested Citation

  • Mark Mink, 2010. "Do Financial Markets Expect Bank Defaults to be Contagious?," DNB Working Papers 274, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:274
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    File URL: https://www.dnb.nl/binaries/274%20-%20Financial%20Markets_tcm46-245129.pdf
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    References listed on IDEAS

    as
    1. 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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    interbank contagion; financial stability; systemic banks; global financial crisis;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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