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Heterogeneity and stability: bolster the strong, not the weak

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  • Dong Beom Choi

Abstract

This paper provides a model of systemic panic among financial institutions with heterogeneous fragilities. Concerns about potential spillovers from each other generate strategic interaction among institutions, triggering a preemption game in which one tries to exit the market before the others to avoid spillovers. Although financial contagion originates in weaker institutions, systemic risk depends critically on the financial health of stronger institutions in the contagion chain. This analysis suggests that when concerns about spillovers prevail, then 1) increasing heterogeneity of institutions promotes systemic stability and 2) bolstering the strong institutions in the contagion chain, rather than the weak, more effectively enhances systemic stability.

Suggested Citation

  • Dong Beom Choi, 2013. "Heterogeneity and stability: bolster the strong, not the weak," Staff Reports 637, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:637
    Note: For a published version of this report, see Dong Beom Choi, "Heterogeneity and Stability: Bolster the Strong, Not the Weak," Review of Financial Studies 27, no. 6 (May 2014): 1830-67.
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    Cited by:

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    2. Berger, Allen N. & Roman, Raluca A. & Sedunov, John, 2020. "Did TARP reduce or increase systemic risk? The effects of government aid on financial system stability," Journal of Financial Intermediation, Elsevier, vol. 43(C).
    3. Allen, Franklin & Carletti, Elena & Goldstein, Itay & Leonello, Agnese, 2018. "Government guarantees and financial stability," Journal of Economic Theory, Elsevier, vol. 177(C), pages 518-557.
    4. King, Michael R., 2019. "Time to buy or just buying time? Lessons from October 2008 for the cross-border bailout of banks," Journal of Financial Stability, Elsevier, vol. 41(C), pages 55-72.
    5. Guimaraes, Bernardo & Pereira, Ana Elisa, 2017. "Dynamic coordination among heterogeneous agents," Journal of Mathematical Economics, Elsevier, vol. 73(C), pages 13-33.
    6. Bo, Wang & Suli, Zheng, 2020. "Heterogeneous fragility, systematic panic and optimal transparency," Economics Letters, Elsevier, vol. 191(C).
    7. Allen N. Berger & Raluca Roman & John Sedunov, 2016. "Do bank bailouts reduce or increase systemic risk? the effects of TARP on financial system stability," Research Working Paper RWP 16-8, Federal Reserve Bank of Kansas City.
    8. Cong, Lin William & Grenadier, Steven R. & Hu, Yunzhi, 2020. "Dynamic interventions and informational linkages," Journal of Financial Economics, Elsevier, vol. 135(1), pages 1-15.
    9. Itay Goldstein & Alexandr Kopytov & Lin Shen & Haotian Xiang, 2020. "Bank Heterogeneity and Financial Stability," NBER Working Papers 27376, National Bureau of Economic Research, Inc.
    10. Catalán, Mario & Hoffmaister, Alexander W. & Harun, Cicilia Anggadewi, 2020. "Bank capital and lending: Evidence of nonlinearity from Indonesia," Journal of Asian Economics, Elsevier, vol. 68(C).
    11. Biswas, Swarnava S. & Gómez, Fabiana, 2018. "Contagion through common borrowers," Journal of Financial Stability, Elsevier, vol. 39(C), pages 125-132.
    12. Guimaraes, Bernardo & Jardanovski, Gabriel, 2021. "Who matters in dynamic coordination problems?," Textos para discussão 543, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).
    13. Injun Hwang & Baeho Kim, 2020. "Heterogeneity and netting efficiency under central clearing: A stochastic network analysis," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(2), pages 192-208, February.
    14. Berger, Allen N. & Molyneux, Phil & Wilson, John O.S., 2020. "Banks and the real economy: An assessment of the research," Journal of Corporate Finance, Elsevier, vol. 62(C).
    15. Zheng, Huanhuan, 2020. "Coordinated bubbles and crashes," Journal of Economic Dynamics and Control, Elsevier, vol. 120(C).
    16. Allen N. Berger, 2018. "The Benefits and Costs of the TARP Bailouts: A Critical Assessment," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 8(02), pages 1-29, June.
    17. Silva, Walmir & Kimura, Herbert & Sobreiro, Vinicius Amorim, 2017. "An analysis of the literature on systemic financial risk: A survey," Journal of Financial Stability, Elsevier, vol. 28(C), pages 91-114.

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    More about this item

    Keywords

    panic; financial spillovers; financial crises;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G00 - Financial Economics - - General - - - General

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