Credit Risk Transfer and Contagion

Franklin Allen () and Elena Carletti ()
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Elena Carletti: Center for Financial Studies, http://www.elenacarletti.com/

No 2005/25, CFS Working Paper Series from Center for Financial Studies

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.

Keywords: Financial Innovation; Pareto Inferior; Banking; Insurance (search for similar items in EconPapers)
JEL-codes: G21 G22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fin, nep-fmk, nep-ias and nep-rmg
Date: 2005-10-09
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Related works:
Journal Article: Credit risk transfer and contagion (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:cfs:cfswop:wp200525

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