Intermediation and voluntary exposure to counterparty risk
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In this article, the authors develop a model of the financial sector in which endogenous intermediation among debt financed banks generates excessive systemic risk, and show that a core-periphery network emerges in their model.Abstract:
I develop a model of the financial sector in which endogenous intermediation among debt financed banks generates excessive systemic risk. Financial institutions have incentives to capture intermediation spreads through strategic borrowing and lending decisions. By doing so, they tilt the division of surplus along an intermediation chain in their favor, while at the same time reducing aggregate surplus. I show that a core-periphery network – few highly interconnected and many sparsely connected banks – endogenously emerges in my model. The network is inefficient relative to a constrained efficient benchmark since banks who make risky investments "overconnect", exposing themselves to excessive counterparty risk, while banks who mainly provide funding end up with too few connections. The predictions of the model are consistent with empirical evidence in the literature.read more
Citations
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Journal ArticleDOI
Systemic Risk and Stability in Financial Networks
Daron Acemoglu,Daron Acemoglu,Daron Acemoglu,Asuman Ozdaglar,Alireza Tahbaz-Salehi,Alireza Tahbaz-Salehi +5 more
TL;DR: In this article, the authors provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk, and show that financial contagion exhibits a form of phase transition as interbank connections increase.
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Where the Risks Lie: A Survey on Systemic Risk
TL;DR: In this paper, the authors review the extensive literature on systemic risk and connect it to the current regulatory debate, and identify a gap between two main approaches: the first one studies different sources of systemic risk in isolation, uses confidential data, and inspires targeted but complex regulatory tools; the second approach uses market data to produce global measures which are not directly connected to any particular theory, but could support a more efficient regulation.
Journal ArticleDOI
Where the Risks Lie: A Survey on Systemic Risk
TL;DR: In this article, the authors review the extensive literature on systemic risk and connect it to the current regulatory debate, and identify a gap between two main approaches: the first one studies different sources of systemic risk in isolation, uses confidential data, and inspires targeted but complex regulatory tools; the second approach uses market data to produce global measures which are not directly connected to any particular theory, but could support a more efficient regulation.
Journal ArticleDOI
The Formation of Financial Networks
TL;DR: In this article, the authors investigate whether banks can commit ex-ante to mutually insure each other, when there is contagion risk in the financial system, and they show that there exists equilibria in which contagion does not occur.
Journal ArticleDOI
Firm Volatility in Granular Networks
Abstract: We propose a model of firm volatility based on customer-supplier connectedness. We assume that customers' growth rate shocks influence the growth rates of their suppliers, larger suppliers have more customers, and the strength of a customer-supplier link depends on the size of the customer firm. When the size distribution becomes more dispersed, economic activity is concentrated among a smaller number of firms, the typical supplier becomes less diversified and its volatility increases. The model is consistent with a set of new stylized facts. At the macro level, the firm volatility distribution is driven by firm size dispersion; the latter explains common movements in firm-level total and residual volatility. At the micro level, we show that the concentration of customer networks is an important determinant of firm-level volatility.
References
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