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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 (Issue 3), vol.�115, mars 2015, p.�471-485.
Handle: RePEc:ide:wpaper:25524
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  1. Allen, F. & Babus, A. & Carletti, E., 2010. "Financial Connections and Systemic Risk," Discussion Paper 2010-88S, Tilburg University, Center for Economic Research.
  2. Francis X. Diebold & Kamil Yılmaz, 2011. "On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms," PIER Working Paper Archive 11-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
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  4. 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.
  5. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress testing the resilience of financial networks," Post-Print hal-00801538, HAL.
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  7. Dimitri Vayanos & Denis Gromb, 2010. "Limits of Arbitrage: The State of the Theory," FMG Discussion Papers dp650, Financial Markets Group.
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  9. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
  10. Andrei Shleifer & Robert W. Vishny, 2010. "Fire Sales in Finance and Macroeconomics," NBER Working Papers 16642, National Bureau of Economic Research, Inc.
  11. Stefano Giglio, 2011. "Credit default swap spreads and systemic financial risk," Proceedings 1122, Federal Reserve Bank of Chicago.
  12. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2010. "Measuring systemic risk," Working Paper 1002, Federal Reserve Bank of Cleveland.
  13. 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.
  14. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers 8793, C.E.P.R. Discussion Papers.
  15. Robin Greenwood & David Thesmar, 2011. "Stock price fragility," Post-Print hal-00635979, HAL.
  16. 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.
  17. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
  18. 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.
  19. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress Testing The Resilience Of Financial Networks," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1250006-1-1.
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