Systemic Risk and Stability in Financial Networks
We provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk. We show that financial contagion exhibits a form of phase transition as interbank connections increase: as long as the magnit...
| Main Authors: | , , |
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| Format: | Working Paper |
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Cambridge, MA: Department of Economics, massachusetts Institute of Technology
2013
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| Online Access: | http://hdl.handle.net/1721.1/77606 |
| _version_ | 1826206449551802368 |
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| author | Acemoglu, Daron Ozdaglar, Asuman Tahbaz-Salehi, Alireza |
| author_facet | Acemoglu, Daron Ozdaglar, Asuman Tahbaz-Salehi, Alireza |
| author_sort | Acemoglu, Daron |
| collection | MIT |
| description | We provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk. We show that financial contagion exhibits a form of phase transition as interbank connections increase: as long as the magnitude and the number of negative shocks affecting financial institutions are sufficiently small, more “complete” interbank claims enhance the stability of the system. However, beyond a certain point, such interconnections start to serve as a mechanism for propagation of shocks and lead to a more fragile financial system. We also show that, under natural contracting assumptions, financial networks that emerge in equilibrium may be socially inefficient due to the presence of a network externality: even though banks take the effects of their lending, risk-taking and failure on their immediate creditors into account, they do not internalize the consequences of their actions on the rest of the network. |
| first_indexed | 2024-09-23T13:30:41Z |
| format | Working Paper |
| id | mit-1721.1/77606 |
| institution | Massachusetts Institute of Technology |
| last_indexed | 2024-09-23T13:30:41Z |
| publishDate | 2013 |
| publisher | Cambridge, MA: Department of Economics, massachusetts Institute of Technology |
| record_format | dspace |
| spelling | mit-1721.1/776062019-04-12T21:40:16Z Systemic Risk and Stability in Financial Networks Acemoglu, Daron Ozdaglar, Asuman Tahbaz-Salehi, Alireza Contagion counterparty risk financial network systemic risk We provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk. We show that financial contagion exhibits a form of phase transition as interbank connections increase: as long as the magnitude and the number of negative shocks affecting financial institutions are sufficiently small, more “complete” interbank claims enhance the stability of the system. However, beyond a certain point, such interconnections start to serve as a mechanism for propagation of shocks and lead to a more fragile financial system. We also show that, under natural contracting assumptions, financial networks that emerge in equilibrium may be socially inefficient due to the presence of a network externality: even though banks take the effects of their lending, risk-taking and failure on their immediate creditors into account, they do not internalize the consequences of their actions on the rest of the network. We are grateful to David Brown, Ozan Candogan, Gary Gorton, Ali Jadbabaie, Jean-Charles Rochet, Alp Simsek, Ali Shourideh and Rakesh Vohra for useful feedback and suggestions. We also thank seminar participants at the 2012 and 2013 AEA Conferences, Chicago Booth, MIT, Stanford GSB, and the Systemic Risk conference at the Goethe University. Acemoglu and Ozdaglar gratefully acknowledge financial support from the Army Research Office, Grant MURI W911NF-12-1-0509. 2013-03-09T00:17:50Z 2013-03-09T00:17:50Z 2011-12-15 Working Paper http://hdl.handle.net/1721.1/77606 Working paper, Massachusetts Institute of Technology, Dept. of Economics;13-03 An error occurred on the license name. An error occurred getting the license - uri. application/pdf Cambridge, MA: Department of Economics, massachusetts Institute of Technology |
| spellingShingle | Contagion counterparty risk financial network systemic risk Acemoglu, Daron Ozdaglar, Asuman Tahbaz-Salehi, Alireza Systemic Risk and Stability in Financial Networks |
| title | Systemic Risk and Stability in Financial Networks |
| title_full | Systemic Risk and Stability in Financial Networks |
| title_fullStr | Systemic Risk and Stability in Financial Networks |
| title_full_unstemmed | Systemic Risk and Stability in Financial Networks |
| title_short | Systemic Risk and Stability in Financial Networks |
| title_sort | systemic risk and stability in financial networks |
| topic | Contagion counterparty risk financial network systemic risk |
| url | http://hdl.handle.net/1721.1/77606 |
| work_keys_str_mv | AT acemogludaron systemicriskandstabilityinfinancialnetworks AT ozdaglarasuman systemicriskandstabilityinfinancialnetworks AT tahbazsalehialireza systemicriskandstabilityinfinancialnetworks |