Financial Firm Bankruptcy and Contagion
66 Pages Posted: 26 Aug 2012 Last revised: 19 Jun 2013
Date Written: May 28, 2013
The Lehman bankruptcy highlights the potential for interconnectedness to cause negative externalities through counterparty contagion, but the externalities may also arise from information contagion. We examine contagion from troubled financial firms and find that counterparty contagion is greater during recessions and in cases of riskier firms and larger and more complex exposures. However, the counterparty exposures are small, especially among banks that face diversification regulations, and do not typically cause a cascade of failures. Information contagion is stronger for rivals in the same locale or the same line of business and is stronger in cases of distress than in bankruptcies.
Keywords: Banks, counterparty contagion, information contagion, bankruptcy
JEL Classification: G21, G24, G28, G32, G33, E44, E58, E61
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