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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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File URL: http://www.tse-fr.eu/sites/default/files/medias/doc/wp/fit/wp_tse_280.pdf
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Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 11-280.

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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:tse:wpaper:25606
Contact details of provider: Phone: (+33) 5 61 12 86 23
Web page: http://www.tse-fr.eu/

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  1. 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.
  2. Robin Greenwood & David Thesmar, 2011. "Stock price fragility," Post-Print hal-00635979, HAL.
  3. 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.
  4. Denis Gromb & Dimitri Vayanos, 2010. "Limits of Arbitrage: The State of the Theory," NBER Working Papers 15821, National Bureau of Economic Research, Inc.
  5. Francis X. Diebold & Kamil Yilmaz, 2011. "On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms," Koç University-TUSIAD Economic Research Forum Working Papers 1124, Koc University-TUSIAD Economic Research Forum.
  6. 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.
  7. Allen, Franklin & Babus, Ana & Carletti, Elena, 2010. "Financial Connections and Systemic Risk," Working Papers 10-20, University of Pennsylvania, Wharton School, Weiss Center.
  8. Hamed Amini & Rama Cont & Andreea Minca, 2012. "Stress testing the resilience of financial networks," Post-Print hal-00801538, HAL.
  9. 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.
  10. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, 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. Ang, Andrew & Longstaff, Francis A., 2013. "Systemic sovereign credit risk: Lessons from the U.S. and Europe," Journal of Monetary Economics, Elsevier, vol. 60(5), pages 493-510.
  13. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers 8793, C.E.P.R. Discussion Papers.
  14. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  15. Greenwood, Robin & Thesmar, David, 2011. "Stock price fragility," Journal of Financial Economics, Elsevier, vol. 102(3), pages 471-490.
  16. 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.
  17. 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.
  18. 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.
  19. 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.
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