Heterogeneity and Stability: Bolster the Strong Not the Weak

52 Pages Posted: 9 Oct 2012 Last revised: 30 Jul 2013

See all articles by Dong Beom Choi

Dong Beom Choi

Seoul National University - Business School

Date Written: July 10, 2013

Abstract

This paper provides a model of systemic panic among financial institutions with heterogeneous fragilities. Concerns about potential spillovers from each other generate strategic interaction among institutions, triggering a pre-emption game in which one tries to exit the market before others to avoid spillovers. Although financial contagion originates in weaker institutions, systemic risk critically depends on financial health of stronger in the contagion chain. Our analysis suggests that when concerns about spillovers prevail, (i) increasing heterogeneity of institutions promotes systemic stability, (ii) bolstering the strong institutions in the contagion chain, rather than the weak, more effectively enhances systemic stability.

JEL Classification: G01, G18, G28

Suggested Citation

Choi, Dong Beom, Heterogeneity and Stability: Bolster the Strong Not the Weak (July 10, 2013). Available at SSRN: https://ssrn.com/abstract=2159403 or http://dx.doi.org/10.2139/ssrn.2159403

Dong Beom Choi (Contact Author)

Seoul National University - Business School ( email )

Seoul
Korea, Republic of (South Korea)

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