Rollover Risk, Network Structure and Systemic Financial Crises

26 Pages Posted: 18 Nov 2009 Last revised: 4 Jan 2011

See all articles by Kartik Anand

Kartik Anand

Technische Universität Berlin (TU Berlin)

Prasanna Gai

Australian National University (ANU)

Matteo Marsili

Abdus Salam International Centre for Theoretical Physics (ICTP)

Date Written: November 16, 2009

Abstract

The breakdown of short-term funding markets was a key feature of the global financial crisis of 2007/8. Combining insights from the literature on global games and network growth, we develop a simple model that sheds light on how network topology interacts with the funding structure of financial institutions to determine system-wide crises. We show how the arrival of bad news about a financial institution leads others to lose confidence in it and how this, in turn, spreads across the entire interbank network. The rate of system-wide bank failure is rendered endogenous, depending crucially on both the rate at which bad news arrives and on the maturity of debt contracts. The conditions under which the financial system makes a sharp transition from a dense network of credit relations to a sparse network where credit freezes readily occur are characterized. Our results also emphasize the role of hysteresis -- once broken, credit relations take a long time to re-establish as a result of common knowledge of the equilibrium. Our findings speak to the importance of tougher liquidity requirements as a means of reducing systemic risk.

Keywords: credit networks, financial markets, credit crises

Suggested Citation

Anand, Kartik and Gai, Prasanna and Marsili, Matteo, Rollover Risk, Network Structure and Systemic Financial Crises (November 16, 2009). Available at SSRN: https://ssrn.com/abstract=1507196 or http://dx.doi.org/10.2139/ssrn.1507196

Kartik Anand (Contact Author)

Technische Universität Berlin (TU Berlin) ( email )

Straße des 17
Juni 135
Berlin, 10623
Germany

Prasanna Gai

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Matteo Marsili

Abdus Salam International Centre for Theoretical Physics (ICTP) ( email )

Strada Costiera 11
Trieste, 34014
Italy

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