Fire Sales in a Model of Complexity

Ricardo Caballero (caball@mit.edu) and Alp Simsek

Journal of Finance, 2013, vol. 68, issue 6, 2549-2587

Abstract: We present a model of financial crises that stem from endogenous complexity. We conceptualize complexity as banks' uncertainty about the financial network of cross exposures. As conditions deteriorate, cross exposures generate the possibility of a domino effect of bankruptcies. As this happens, banks face an increasingly complex environment since they need to understand a greater fraction of the financial network to assess their own financial health. Complexity dramatically amplifies banks' perceived counterparty risk, and makes relatively healthy banks reluctant to buy risky assets. The model also features a novel complexity externality.

Date: 2013
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Citations: View citations in EconPapers (169)

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https://doi.org/10.1111/jofi.12087

Related works:
Working Paper: Fire Sales in a Model of Complexity (2010)
Working Paper: Fire Sales in a Model of Complexity (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:68:y:2013:i:6:p:2549-2587

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