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Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk / Stefano Battiston, Domenico Delli Gatti, Mauro Gallegati, Bruce C. Greenwald, Joseph E. Stiglitz.
- Format:
- Book
- Author/Creator:
- Battiston, Stefano.
- Series:
- Working Paper Series (National Bureau of Economic Research) no. w15611.
- NBER working paper series no. w15611
- Language:
- English
- Physical Description:
- 1 online resource: illustrations (black and white);
- Other Title:
- Liaisons Dangereuses
- Place of Publication:
- Cambridge, Mass. National Bureau of Economic Research 2009.
- Summary:
- We characterize the evolution over time of a network of credit relations among financial agents as a system of coupled stochastic processes. Each process describes the dynamics of individual financial robustness, while the coupling results from a network of liabilities among agents. The average level of risk diversification of the agents coincides with the density of links in the network. In addition to a process of diffusion of financial distress, we also consider a discrete process of default cascade, due to the re-evaluation of agents' assets. In this framework we investigate the probability of individual defaults as well as the probability of systemic default as a function of the network density. While it is usually thought that diversification of risk always leads to a more stable financial system, in our model a tension emerges between individual risk and systemic risk. As the number of counterparties in the credit network increases beyond a certain value, the default probability, both individual and systemic, starts to increase. This tension originates from the fact that agents are subject to a financial accelerator mechanism. In other words, individual financial fragility feeding back on itself may amplify the effect of an initial shock and lead to a full fledged systemic crisis. The results offer a simple possible explanation for the endogenous emergence of systemic risk in a credit network.
- Notes:
- January 2009.
- Print version record
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