Systemic Risk and Stability in Financial Networks

Daron Acemoglu, Asuman Ozdaglar and Alireza Tahbaz-Salehi

No 18727, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We provide a framework for studying the relationship between the financial network architecture and the likelihood of systemic failures due to contagion of counterparty risk. We show that financial contagion exhibits a form of phase transition as interbank connections increase: as long as the magnitude and the number of negative shocks affecting financial institutions are sufficiently small, more "complete" interbank claims enhance the stability of the system. However, beyond a certain point, such interconnections start to serve as a mechanism for propagation of shocks and lead to a more fragile financial system. We also show that, under natural contracting assumptions, financial networks that emerge in equilibrium may be socially inefficient due to the presence of a network externality: even though banks take the effects of their lending, risk-taking and failure on their immediate creditors into account, they do not internalize the consequences of their actions on the rest of the network.

JEL-codes: D85 G01 (search for similar items in EconPapers)
Date: 2013-01
New Economics Papers: this item is included in nep-ban, nep-cba and nep-net
Note: CF DEV EFG IFM
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Citations: View citations in EconPapers (137)

Published as Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2015. "Systemic Risk and Stability in Financial Networks," American Economic Review, American Economic Association, vol. 105(2), pages 564-608, February.

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Journal Article: Systemic Risk and Stability in Financial Networks (2015)
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