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How Likely is Contagion in Financial Networks?

Author

Listed:
  • Paul Glasserman

    () (Columbia Business School, Columbia University)

  • Peyton Young

    () (Office of Financial Research)

Abstract

Interconnections among financial institutions create potential channels for contagion and amplification of shocks to the financial system. We estimate the extent to which interconnections increase expected losses, with minimal information about network topology, under a wide range of shock distributions. Expected losses from network effects are small without substantial heterogeneity in bank sizes and a high degree of reliance on interbank funding. They are also small unless shocks are magnified by some mechanism beyond simple spillover effects; these include bankruptcy costs, fire sales, and mark-to-market revaluations of assets. We illustrate the results with data on the European banking system.

Suggested Citation

  • Paul Glasserman & Peyton Young, 2013. "How Likely is Contagion in Financial Networks?," Working Papers 13-06, Office of Financial Research, US Department of the Treasury.
  • Handle: RePEc:ofr:wpaper:13-06
    as

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    File URL: http://financialresearch.gov/working-papers/files/OFRwp0009_GlassermanYoung_HowLikelyContagionFinancialNetworks.pdf
    File Function: First version, 2013
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    References listed on IDEAS

    as
    1. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
    2. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 107-142, January.
    3. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers 8793, C.E.P.R. Discussion Papers.
    4. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    5. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
    6. Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
    7. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, vol. 52(9), pages 1301-1314, September.
    8. Goodhart, Charles A. E. & Sunirand, Pojanart & Tsomocos, Dimitrios P., 2004. "A model to analyse financial fragility: applications," Journal of Financial Stability, Elsevier, vol. 1(1), pages 1-30, September.
    9. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
    10. Degryse, H.A. & Nguyen, G., 2004. "Interbank Exposures : An Empirical Examination of Systemic Risk in the Belgian Banking System," Discussion Paper 2004-4, Tilburg University, Center for Economic Research.
    11. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    12. Goodhart, Charles A. E. & Sunirand, Pojanart & Tsomocos, Dimitrios P., 2004. "A model to analyse financial fragility: applications," Journal of Financial Stability, Elsevier, vol. 1(1), pages 1-30, September.
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    Citations

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    Cited by:

    1. Georgescu, Oana-Maria, 2015. "Contagion in the interbank market: Funding versus regulatory constraints," Journal of Financial Stability, Elsevier, vol. 18(C), pages 1-18.
    2. Andrea Aguiar & Rick Bookstaber & Thomas Wipf, 2014. "A Map of Funding Durability and Risk," Working Papers 14-03, Office of Financial Research, US Department of the Treasury.
    3. Matthew Elliott & Benjamin Golub & Matthew O. Jackson, 2014. "Financial Networks and Contagion," American Economic Review, American Economic Association, vol. 104(10), pages 3115-3153, October.
    4. repec:aud:audfin:v:15:y:2017:i:147:p:418 is not listed on IDEAS
    5. Hamed Amini & Andreea Minca, 2014. "Inhomogeneous Financial Networks and Contagious Links," Working Papers hal-01081559, HAL.
    6. repec:spr:annopr:v:247:y:2016:i:2:d:10.1007_s10479-015-1857-x is not listed on IDEAS

    More about this item

    Keywords

    systemic risk; contagion; financial network;

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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