Endogenous Response to the ‘Network Tax’

José Pedro Fique ()
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José Pedro Fique: Faculdade de Economia da Universidade do Porto and LIAAD, INESC-Porto

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: The turmoil in the financial markets that had its roots in the 2007 US subprime crisis prompted government action all over the world motivated by contagion concerns, leaving a heavy bill for the tax payers to pick up. We find that a contributory regime based on contagion risk exposure changes the trade-off between liquidity coinsurance and counterparty risk that motivates the formation of the financial network in the first place, potentially leading to a less connected architecture. Furthermore, if that regime bestows the weight of the levy on both borrower and lender it has the potential to shift the system towards safer grounds. Since we model bank interactions as a network formation game, we are able to provide an account of the changes that come into play with the introduction of tax, which can be a fundamental factor in the design process of the policy function.

Keywords: Financial Network; Regulation; Counterparty Risk; Liquidity Coinsurance (search for similar items in EconPapers)
JEL-codes: D85 G18 G21 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2011-03
New Economics Papers: this item is included in nep-ban, nep-net, nep-pke and nep-reg
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Persistent link: https://EconPapers.repec.org/RePEc:por:fepwps:408

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