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Matthew O. Jackson - One of the best experts on this subject based on the ideXlab platform.
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Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks.
2020Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:We analyze how interdependencies between organizations in Financial Networks can lead to multiple possible equilibrium outcomes. A multiplicity arises if and only if there exists a certain type of dependency cycle in the network that allows for self-fulfilling chains of defaults. We provide necessary and sufficient conditions for banks' solvency in any equilibrium. Building on these conditions, we characterize the minimum bailout payments needed to ensure systemic solvency, as well as how solvency can be ensured by guaranteeing a specific set of debt payments. Bailout injections needed to eliminate self-fulfilling cycles of defaults (credit freezes) are fully recoverable, while those needed to prevent cascading defaults outside of cycles are not. We show that the minimum bailout problem is computationally hard, but provide an upper bound on optimal payments and show that the problem has intuitive solutions in specific network structures such as those with disjoint cycles or a core-periphery structure.
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credit freezes equilibrium multiplicity and optimal bailouts in Financial Networks
Social Science Research Network, 2020Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:We analyze how interdependencies in Financial Networks can lead to self-fulfilling insolvencies and multiple possible equilibrium outcomes. We show that multiplicity arises if and only if there exists a certain type of dependency cycle in the network, and characterize banks' solvency in any equilibrium. We use this analysis to understand how to inject capital into banks so as to ensure solvency of all at minimum cost. We show that finding the cheapest bailout policy that prevents self-fulfilling insolvencies is computationally hard (and hard to approximate), but that the problem has intuitive solutions in specific network structures. Bailouts have an indirect value as making a bank solvent improves its creditors' balance-sheets and reduces their bailout costs, and we show how a simple algorithm that leverages these indirect benefits ensures systemic solvency at a total cost that never exceeds half of the total overall shortfall. In core-periphery Networks, indirect bailouts -- whereby the regulator bails out peripheral banks first as opposed to targeting core banks directly -- are part of an optimal policy.
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investment incentives and regulation in Financial Networks
Social Science Research Network, 2019Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:In a model of Financial Networks that admits both debt and equity interdependencies, we show that Financial organizations have incentives to choose excessively risky portfolios, and overly correlate their portfolios with those of their counterparties. We show how optimal regulation differs as a function of an organization's Financial centrality and its available investment opportunities. We discover that optimal regulation depends non-monotonically on the correlation of banks' investments, with maximal restrictions for intermediate levels of correlation. Moreover, in standard core-periphery Networks it can be uniquely optimal to treat banks asymmetrically: restricting the investments of one core bank while allowing an otherwise identical core bank (in all aspects, including in network centrality) to invest freely.
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Financial Networks and contagion
The American Economic Review, 2014Co-Authors: Matthew Elliott, Benjamin Golub, Matthew O. JacksonAbstract:*We study cascades of failures in a network of interdependent Financial organizations: how discontinuous changes in asset values (e.g., defaults and shutdowns) trigger further failures, and how this depends on network structure. Integration (greater dependence on counterparties) and diversification (more counterparties per organization) have different, nonmonotonic effects on the extent of cascades. Diversification connects the network initially, permitting cascades to travel; but as it increases further, organizations are better insured against one another’s failures. Integration also faces trade-offs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate the model with data on European debt cross-holdings. (JEL D85, F15, F34, F36, F65, G15, G32, G33, G38) Globalization brings with it increased Financial interdependencies among many kinds of organizations—governments, central banks, investment banks, firms, etc.— that hold each other’s shares, debts, and other obligations. Such interdependencies can lead to cascading defaults and failures, which are often avoided through massive bailouts of institutions deemed “too big to fail.” Recent examples include the US government’s interventions in AIG, Fannie Mae, Freddie Mac, and General Motors; and the European Commission’s interventions in Greece and Spain. Although such bailouts circumvent the widespread failures that were more prevalent in the nineteenth and early twentieth centuries, they emphasize the need to study the risks created by a network of interdependencies. Understanding these risks is crucial to designing incentives and regulatory responses which defuse cascades before they are imminent. In this paper we develop a general model that produces new insights regarding Financial contagions and cascades of failures among organizations linked through a network of Financial interdependencies. Organizations’ values depend on each other—e.g., through cross-holdings of shares, debt, or other liabilities. If an
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Financial Networks and contagion
The American Economic Review, 2014Co-Authors: Matthew Elliott, Benjamin Golub, Matthew O. JacksonAbstract:We study cascades of failures in a network of interdependent Financial organizations: how discontinuous changes in asset values (e.g., defaults and shutdowns) trigger further failures, and how this depends on network structure. Integration (greater dependence on counterparties) and diversification (more counterparties per organization) have different, nonmonotonic effects on the extent of cascades. Diversification connects the network initially, permitting cascades to travel; but as it increases further, organizations are better insured against one another's failures. Integration also faces trade-offs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate the model with data on European debt cross-holdings.
Gabrielle Demange - One of the best experts on this subject based on the ideXlab platform.
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contagion in Financial Networks a threat index
Management Science, 2018Co-Authors: Gabrielle DemangeAbstract:This paper proposes to measure the spillover effects that cross liabilities generate on the magnitude of default in a system of Financially linked institutions. Based on a simple model and an explicit criterion-the aggregate debt repayments-the measure is defined for each institution, affected by its characteristics and links to others. These measures-one for each institution-summarize relevant information on the interaction between the liabilities structure and the shocks to resources, and they can be useful to determine optimal intervention policies. The approach is illustrated to evaluate the consolidated foreign claims of 10 European Union countries. This paper was accepted by Amit Seru, finance.
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contagion in Financial Networks a threat index
PSE-Ecole d'économie de Paris (Postprint), 2018Co-Authors: Gabrielle DemangeAbstract:This paper proposes to measure the spillover effects that cross liabilities generate on the magnitude of default in a system of Financially linked institutions. Based on a simple model and an explicit criterion—the aggregate debt repayments—the measure is defined for each institution, affected by its characteristics and links to others. These measures—one for each institution—summarize relevant information on the interaction between the liabilities structure and the shocks to resources, and they can be useful to determine optimal intervention policies. The approach is illustrated to evaluate the consolidated foreign claims of 10 European Union countries.
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Contagion in Financial Networks: a threat index
2016Co-Authors: Gabrielle DemangeAbstract:This paper proposes to measure the spill-over effects that cross-liabilities generate on the magnitude of default in a system of Financially linked institutions. Based on a simple model and an explicit criterion -the aggregate debt repayments- the measure is defined for each institution, affected by its characteristics and links to others. These measures -one for each institutionsummarize relevant information on the interaction between the liabilities structure and the shocks to resources and they can be useful to determine optimal intervention policies. The approach is illustrated to evaluate the consolidated foreign claims of 10 EU countries
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contagion in Financial Networks a threat index
Social Science Research Network, 2012Co-Authors: Gabrielle DemangeAbstract:An intricate web of claims and obligations ties together the balance sheets of a wide variety of Financial institutions. Under the occurrence of default, these interbank claims generate externalities across institutions and possibly disseminate defaults and bankruptcy. Building on a simple model for the joint determination of the repayments of interbank claims, this paper introduces a measure of the threat that a bank poses to the system. Such a measure, called threat index, may be helpful to determine how to inject cash into banks so as to increase debt reimbursement, or to assess the contributions of individual institutions to the risk in the system. Although the threat index and the default level of a bank both reflect some form of weakness and are affected by the whole liability network, the two indicators differ. As a result, injecting cash into the banks with the largest default level may not be optimal.
Agathe Pernoud - One of the best experts on this subject based on the ideXlab platform.
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Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks.
2020Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:We analyze how interdependencies between organizations in Financial Networks can lead to multiple possible equilibrium outcomes. A multiplicity arises if and only if there exists a certain type of dependency cycle in the network that allows for self-fulfilling chains of defaults. We provide necessary and sufficient conditions for banks' solvency in any equilibrium. Building on these conditions, we characterize the minimum bailout payments needed to ensure systemic solvency, as well as how solvency can be ensured by guaranteeing a specific set of debt payments. Bailout injections needed to eliminate self-fulfilling cycles of defaults (credit freezes) are fully recoverable, while those needed to prevent cascading defaults outside of cycles are not. We show that the minimum bailout problem is computationally hard, but provide an upper bound on optimal payments and show that the problem has intuitive solutions in specific network structures such as those with disjoint cycles or a core-periphery structure.
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credit freezes equilibrium multiplicity and optimal bailouts in Financial Networks
Social Science Research Network, 2020Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:We analyze how interdependencies in Financial Networks can lead to self-fulfilling insolvencies and multiple possible equilibrium outcomes. We show that multiplicity arises if and only if there exists a certain type of dependency cycle in the network, and characterize banks' solvency in any equilibrium. We use this analysis to understand how to inject capital into banks so as to ensure solvency of all at minimum cost. We show that finding the cheapest bailout policy that prevents self-fulfilling insolvencies is computationally hard (and hard to approximate), but that the problem has intuitive solutions in specific network structures. Bailouts have an indirect value as making a bank solvent improves its creditors' balance-sheets and reduces their bailout costs, and we show how a simple algorithm that leverages these indirect benefits ensures systemic solvency at a total cost that never exceeds half of the total overall shortfall. In core-periphery Networks, indirect bailouts -- whereby the regulator bails out peripheral banks first as opposed to targeting core banks directly -- are part of an optimal policy.
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investment incentives and regulation in Financial Networks
Social Science Research Network, 2019Co-Authors: Matthew O. Jackson, Agathe PernoudAbstract:In a model of Financial Networks that admits both debt and equity interdependencies, we show that Financial organizations have incentives to choose excessively risky portfolios, and overly correlate their portfolios with those of their counterparties. We show how optimal regulation differs as a function of an organization's Financial centrality and its available investment opportunities. We discover that optimal regulation depends non-monotonically on the correlation of banks' investments, with maximal restrictions for intermediate levels of correlation. Moreover, in standard core-periphery Networks it can be uniquely optimal to treat banks asymmetrically: restricting the investments of one core bank while allowing an otherwise identical core bank (in all aspects, including in network centrality) to invest freely.
Lauramarie Topfer - One of the best experts on this subject based on the ideXlab platform.
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china s integration into the global Financial system toward a state led conception of global Financial Networks
Dialogues in human geography, 2018Co-Authors: Lauramarie TopferAbstract:This article critically reviews theories of global economic Networks and refines their application to China’s state-controlled Financial sector. Current approaches view global production Networks a...
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inside global Financial Networks the state lead firms and the rise of fintech
Dialogues in human geography, 2018Co-Authors: Lauramarie TopferAbstract:The commentaries on this forum’s anchor article, ‘China’s Integration into the Global Financial System: Toward a State-led Conception of Global Financial Networks’, examine how the state is shaping...
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capital market access in china the role of power resources in global Financial Networks
2015Co-Authors: Lauramarie TopferAbstract:This paper investigates the empirical puzzle of asymmetric capital market access in China. The existing literature has focused on corporate monopolies, technological advances and the power of lead firms. However, the role of the political decision-making process behind market access has been neglected. This study fills an analytical void, by highlighting the role of corporate power resources in shaping the receptiveness of the Chinese government toward foreign investors. Based on a large new dataset coupling interviews with database analysis, this paper demonstrates that these power resources are decisive for explaining asymmetric market access across foreign investors. They highlight that market access is a negotiated economic outcome that bridges bargaining processes between interdependent state and market agents. The results have important implications for the study of globalisation and institutional change. They challenge dominant claims that policymaking systems are resistant to change and that the global spread of liberal market forces has led to the retreat of the state.
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cross border Networks in china s Financial markets the role of power resources in firm government relations
2015Co-Authors: Lauramarie TopferAbstract:This paper introduces an interdisciplinary theoretical framework that explains why the cross-border relationship between foreign firms and the domestic government is crucial for understanding capital market access in China. In recent years, more nuanced conceptualisations of power and the agents exerting it have advanced our understanding of the ways in which global production Networks shape regional economic outcomes. Yet, the literature has focused on descriptive accounts of how different types of power are exercised rather than explaining why they matter. Moreover, Financial Networks in emerging markets have been neglected despite their growing role in the global economy. This paper addresses these shortcomings, by investigating cross-border Financial Networks operating in the less frequently studied yet increasingly important Chinese Financial system. By exploiting conceptual synergies between economic geography, political economy and regional studies, an analytical framework is developed that outlines an exchange relationship between foreign firms and the Chinese government. This framework identifies decisive ‘power resources’ that explain the asymmetrical market access granted to foreign firms by the Chinese government. This emphasis on causal mechanisms allows for moving beyond descriptive treatments of ‘power’ and opens up a promising agenda for empirical research.
Peyton H Young - One of the best experts on this subject based on the ideXlab platform.
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contagion in Financial Networks
LSE Research Online Documents on Economics, 2016Co-Authors: Paul Glasserman, Peyton H YoungAbstract:The recent Financial crisis has prompted much new research on the interconnectedness of the modern Financial system and the extent to which it contributes to systemic fragility. Network connections diversify firms' risk exposures, but they also create channels through which shocks can spread by contagion. We review the extensive literature on this issue, with the focus on how network structure interacts with other key variables such as leverage, size, common exposures, and short-term funding. We discuss various metrics that have been proposed for evaluating the susceptibility of the system to contagion and suggest directions for future research.
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contagion in Financial Networks
Social Science Research Network, 2015Co-Authors: Paul Glasserman, Peyton H YoungAbstract:This paper surveys the rapidly growing literature about interconnectedness and Financial stability. The paper focuses on insights in the literature on the relationship between network structure and the vulnerability of the Financial system to contagion.
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how likely is contagion in Financial Networks
Journal of Banking and Finance, 2015Co-Authors: Paul Glasserman, Peyton H YoungAbstract:Interconnections among Financial institutions create potential channels for contagion and amplification of shocks to the Financial system. We estimate the extent to which interconnections increase expected losses and defaults under a wide range of shock distributions. In contrast to most work on Financial Networks, we assume only minimal information about network structure and rely instead on information about the individual institutions that are the nodes of the network. The key node-level quantities are asset size, leverage, and a Financial connectivity measure given by the fraction of a Financial institution’s liabilities held by other Financial institutions. We combine these measures to derive explicit bounds on the potential magnitude of network effects on contagion and loss amplification. Spillover effects are most significant when node sizes are heterogeneous and the originating node is highly leveraged and has high Financial connectivity. Our results also highlight the importance of mechanisms that go beyond simple spillover effects to magnify shocks; these include bankruptcy costs, and mark-to-market losses resulting from credit quality deterioration or a loss of confidence. We illustrate the results with data on the European banking system. 2014 Published by Elsevier B.V.
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how likely is contagion in Financial Networks
Journal of Banking and Finance, 2015Co-Authors: Paul Glasserman, Peyton H YoungAbstract:Interconnections among Financial institutions create potential channels for contagion and amplification of shocks to the Financial system. We estimate the extent to which interconnections increase expected losses, with minimal information about network topology, under a wide range of shock distributions. Expected losses from network effects are small without substantial heterogeneity in bank sizes and a high degree of reliance on interbank funding. They are also small unless shocks are magnified by some mechanism beyond simple spillover effects; these include bankruptcy costs, fire sales, and mark-to-market revaluations of assets. We illustrate the results with data on the European banking system.
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how likely is contagion in Financial Networks
Research Papers in Economics, 2013Co-Authors: Paul Glasserman, Peyton H YoungAbstract:Interconnections among Financial institutions create potential channels for contagion and amplification of shocks to the Financial system. We propose precise definitions of these concepts and analyze their magnitude. Contagion occurs when a shock to the assets of a single firm causes other firms to default through the network of obligations; amplification occurs when losses among defaulting nodes keep escalating due to their indebtedness to one another. Contagion is weak if the probability of default through contagion is no greater than the probability of default through independent direct shocks to the defaulting nodes. We derive a general formula which shows that, for a wide variety of shock distributions, contagion is weak unless the triggering node is large and/or highly leveraged compared to the nodes it topples through contagion. We also estimate how much the interconnections between nodes increase total losses beyond the level that would be incurred without interconnections. A distinguishing feature of our approach is that the results do not depend on the specific topology: they hold for any Financial network with a given distribution of bank sizes and leverage levels. We apply the framework to European Banking Authority data and show that both the probability of contagion and the expected increase in losses are small under a wide variety of shock distributions. Our conclusion is that the direct transmission of shocks through payment obligations does not have a major effect on defaults and losses; other mechanisms such as loss of confidence and declines in credit quality are more llikely sources of contagion.