Contagion in debt and collateral markets

Jin-Wook Chang and Grace Chuan

Journal of Monetary Economics, 2024, vol. 148, issue C

Abstract: This paper investigates contagion in financial networks through collateralized debt and its effects on social welfare. Our model incorporates contagion through both counterparty debt exposures and endogenous collateral asset pricing. We find that collateral mitigates counterparty exposures and reduces social inefficiency when faced with negative shocks, but not always. We also show the importance of the interaction between the level of collateral and network structure as contagion can change dramatically depending on that interaction. The model also provides policy-relevant collateral-to-debt ratios (haircuts) to attain robust and fully insulated macroprudential states for any network and also the optimal collateral ratio to attain full insulation for a specific network.

Keywords: Collateral; Financial network; Fire sale; Systemic risk (search for similar items in EconPapers)
JEL-codes: D49 D53 G01 G21 G33 (search for similar items in EconPapers)
Date: 2024
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Related works:
Working Paper: Contagion in Debt and Collateral Markets (2023)
Working Paper: Contagion in Debt and Collateral Markets (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:148:y:2024:i:c:s0304393224000539

DOI: 10.1016/j.jmoneco.2024.103600

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