Systemic risk shifting in financial networks

Matthew Elliott, Co-Pierre Georg and Jonathon Hazell

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Banks face different but potentially correlated risks from outside the financial system. Financial connections can share these risks, but they also create the means by which shocks can be propagated. We examine this tradeoff in the context of a new stylized fact we present: German banks are more likely to have financial connections when they face more similar risks. We develop a model that can rationalize such behavior. We argue that such patterns are socially suboptimal and raise systemic risk, but can be explained by risk shifting. Risk shifting motivates banks to correlate their failures with their counterparties, even though it creates systemic risk.

Keywords: financial networks; asset correlation; contagion (search for similar items in EconPapers)
JEL-codes: D85 G11 G21 (search for similar items in EconPapers)
Date: 2021-01-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published in Journal of Economic Theory, 1, January, 2021, 191, pp. 105157. ISSN: 0022-0531

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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:123924

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