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Financial networks and contagion

Friday 10th October 2014
American Economic Review
Elliott, M., Golub, B. and Jackson, M.O.
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.
Keywords
D85
F34
F65
G15
G32
G33
H63
Themes
networks
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