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Vulnerable Banks

  • Greenwood, Robin
  • Landier, Augustin
  • Thesmar, David

When a bank experiences an adverse shock to its equity capital, one way to return to target leverage is to sell assets. The price impact of the fire sale may impact other institutions with common exposures, resulting in contagion. We propose a simple framework that accounts for this effect. This framework explains how the distribution of leverage and risk exposures across banks contributes to systemic risk. We use it to compute a bank's exposure to sector-wide deleveraging, as well as the spillover of a bank's deleveraging onto other banks. We explain how the model can be used to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. We then apply the framework to measure (a) the vulnerability of European banks to sovereign risk in 2010 and 2011, and (b) the vulnerability of US financial institutions between 2001 and 2010. In our model, \microprudential" interventions, which target the solvency of individual banks are always less effective than \macroprudential", policies which aim to minimize spillovers across firms.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 700.

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Date of creation: Nov 2011
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Publication status: Published in Journal of Financial Economics, 2015.
Handle: RePEc:ide:wpaper:25524
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  1. Stefano Giglio, 2011. "Credit default swap spreads and systemic financial risk," Proceedings 1122, Federal Reserve Bank of Chicago.
  2. Andrew Ang & Francis A. Longstaff, 2011. "Systemic Sovereign Credit Risk: Lessons from the U.S. and Europe," NBER Working Papers 16982, National Bureau of Economic Research, Inc.
  3. Dimitri Vayanos & Denis Gromb, 2010. "Limits of Arbitrage: The State of the Theory," FMG Discussion Papers dp650, Financial Markets Group.
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  5. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Working Papers 16177, National Bureau of Economic Research, Inc.
  6. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
  7. Andrei Shleifer & Robert W. Vishny, 2010. "Fire Sales in Finance and Macroeconomics," NBER Working Papers 16642, National Bureau of Economic Research, Inc.
  8. Viral V. Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? The Case of Asset-Backed Commercial Paper During the Financial Crisis of 2007-09," NBER Working Papers 16079, National Bureau of Economic Research, Inc.
  9. Acharya, Viral V & Pedersen, Lasse H & Philippon, Thomas & Richardson, Matthew P, 2012. "Measuring Systemic Risk," CEPR Discussion Papers 8824, C.E.P.R. Discussion Papers.
  10. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  11. Viral V Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? Asset-Backed Commercial Paper during the Financial Crisis of 2007–09," IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 37-73, August.
  12. Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, vol. 66(4), pages 1141-1175, 08.
  13. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  14. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  15. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
  16. Gabrielle Demange, 2012. "Contagion in financial networks: a threat index," PSE Working Papers halshs-00662513, HAL.
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