Financial Networks and Contagion

61 Pages Posted: 10 Dec 2012 Last revised: 28 Jan 2014

Matthew Elliott

California Institute of Technology - Division of the Humanities and Social Sciences

Benjamin Golub

Harvard University

Matthew O. Jackson

Stanford University - Department of Economics; Santa Fe Institute; Canadian Institute for Advanced Research (CIFAR)

Date Written: January 2014

Abstract

We model contagions and cascades of failures among organizations linked through a network of financial interdependencies. We identify how the network propagates discontinuous changes in asset values triggered by failures (e.g., bankruptcies, defaults, and other insolvencies) and use that to study the consequences of integration (each organization becoming more dependent on its counterparties) and diversification (each organization interacting with a larger number of counterparties). Integration and diversification have different, nonmonotonic effects on the extent of cascades. Initial increases in diversification connect the network which permits cascades to propagate further, but eventually, more diversification makes contagion between any pair of organizations less likely as they become less dependent on each other. Integration also faces tradeoffs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate some aspects of the model with data on European debt cross-holdings.

Keywords: financial networks, networks, contagion, cascades, financial crises, bankruptcy, diversification, integration, globalization

JEL Classification: G32, D85, G01, F36, G33, G38, F15

Suggested Citation

Elliott, Matthew and Golub, Benjamin and Jackson, Matthew O., Financial Networks and Contagion (January 2014). Available at SSRN: https://ssrn.com/abstract=2175056 or http://dx.doi.org/10.2139/ssrn.2175056

Matthew Elliott

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
Pasadena, CA 91125
United States

Benjamin Golub

Harvard University ( email )

Littauer Center, Dept of Economics
1805 Cambridge Street
Cambridge, MA 02138
United States

Matthew O. Jackson (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States
1-650-723-3544 (Phone)

HOME PAGE: http://www.stanford.edu/~jacksonm

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Canadian Institute for Advanced Research (CIFAR) ( email )

180 Dundas Street West, Suite 1400
Toronto, Ontario
Canada

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