Systemic risk shifting in financial networks

Elliott, Matthew, Georg, Co-Pierre and Hazell, Jonathon ORCID: 0009-0002-4930-7946 (2021) Systemic risk shifting in financial networks. Journal of Economic Theory, 191. p. 105157. ISSN 0022-0531

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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.

Item Type:	Article
Additional Information:	© 2024 The Author(s)
Divisions:	LSE
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D85 - Network Formation and Analysis: Theory
Date Deposited:	19 Jun 2024 15:39
Last Modified:	12 Dec 2024 04:20
URI:	http://eprints.lse.ac.uk/id/eprint/123924

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