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Credit risk transfer and contagion

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  • Allen, Franklin
  • Carletti, Elena

Abstract

Some have argued that recent increases in credit risk transfer are desirable because they improve the diversification of risk. Others have suggested that they may be undesirable if they increase the risk of financial crises. Using a model with banking and insurance sectors, we show that credit risk transfer can be beneficial when banks face uniform demand for liquidity. However, when they face idiosyncratic liquidity risk and hedge this risk in an interbank market, credit risk transfer can be detrimental to welfare. It can lead to contagion between the two sectors and increase the risk of crises.

Suggested Citation

  • Allen, Franklin & Carletti, Elena, 2005. "Credit risk transfer and contagion," CFS Working Paper Series 2005/25, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:200525
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    References listed on IDEAS

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    1. repec:ucp:bknber:9780226454627 is not listed on IDEAS
    2. Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
    3. Wagner, Wolf & Marsh, Ian W., 2006. "Credit risk transfer and financial sector stability," Journal of Financial Stability, Elsevier, vol. 2(2), pages 173-193, June.
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    7. Franklin Allen & Douglas Gale, 1990. "Incomplete Markets and Incentives to Set Up an Options Exchange*," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 15(1), pages 17-46, March.
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    13. Guillaume Plantin & Christine A Parlour, "undated". "Credit Risk Transfer," GSIA Working Papers 2005-E45, Carnegie Mellon University, Tepper School of Business.
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    More about this item

    Keywords

    Financial Innovation; Pareto Inferior; Banking; Insurance;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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