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Uncertainty in an Interconnected Financial System, Contagion

Author

Listed:
  • Mei Li

    () (Department of Economics and Finance,University of Guelph)

  • Frank Milne

    () (Department of Economics, Queen's University)

  • Junfeng Qiu

    () (China Economics and Management Academy, Central University of Finance and Economics)

Abstract

This paper studies contagion and market freezes caused by uncertainty in financial network structures and provides theoretical guidance for central banks. We establish a formal model to demonstrate that, in a financial system where financial institutions are interconnected, a negative shock to an individual financial institution could spread to other institutions, causing market freezes because of creditors' uncertainty about the financial network structure. Central bank policies to alleviate market freezes and contagion, such as information policy, bailout policy and the lender of last resort policy, are examined.

Suggested Citation

  • Mei Li & Frank Milne & Junfeng Qiu, 2013. "Uncertainty in an Interconnected Financial System, Contagion," Working Papers 1304, University of Guelph, Department of Economics and Finance.
  • Handle: RePEc:gue:guelph:2013-04.
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    References listed on IDEAS

    as
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    3. Douglas W. Diamond & Raghuram G. Rajan, 2011. "Fear of Fire Sales, Illiquidity Seeking, and Credit Freezes," The Quarterly Journal of Economics, Oxford University Press, vol. 126(2), pages 557-591.
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    Citations

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    Cited by:

    1. Mei Li & Frank Milne & Junfen Qiu, 2013. "Central Bank Screening, Moral Hazard, and the Lender of Last Resort Policy," Working Papers 1317, Queen's University, Department of Economics.

    More about this item

    Keywords

    Interconnection; Market Freezes; Contagion; Financial Crises;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G2 - Financial Economics - - Financial Institutions and Services

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