Financial Connections and Systemic Risk

Franklin Allen, Ana Babus and Elena Carletti ()

No 16177, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a model where institutions form connections through swaps of projects in order to diversify their individual risk. These connections lead to two different network structures. In a clustered network groups of financial institutions hold identical portfolios and default together. In an unclustered network defaults are more dispersed. With long term finance welfare is the same in both networks. In contrast, when short term finance is used, the network structure matters. Upon the arrival of a signal about banks' future defaults, investors update their expectations of bank solvency. If their expectations are low, they do not roll over the debt and there is systemic risk in that all institutions are early liquidated. We compare investors' rollover decisions and welfare in the two networks.

JEL-codes: G01 G11 G2 G21 (search for similar items in EconPapers)
Date: 2010-07
Note: CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (94)

Published as Asset Commonality, Debt Maturity, and Systemic Risk , Franklin Allen, Ana Babus, Elena Carletti. in Market Institutions and Financial Market Risk , Carey, Kashyap, Rajan, and Stulz. 2012

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Related works:
Working Paper: Financial Connections and Systemic Risk (2010)
Working Paper: Financial Connections and Systemic Risk (2010)
Working Paper: Financial Connections and Systemic Risk (2010)
Working Paper: Financial Connections and Systemic Risk (2010)
Working Paper: Financial Connections and Systemic Risk (2010)
Working Paper: Financial Connections and Systemic Risk (2010)
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