Systemic Risk-Shifting in Financial Networks

52 Pages Posted: 11 Sep 2015 Last revised: 20 Aug 2018

See all articles by Matthew Elliott

Matthew Elliott

Cambridge University

Jonathon Hazell

Massachusetts Institute of Technology (MIT)

Co-Pierre Georg

University of Cape Town; Deutsche Bundesbank

Date Written: June 2, 2018

Abstract

Banks face different but potentially correlated risks from outside the financial system. Financial connections can help hedge these risks, but also create the means by which shocks can propagate. We examine this tradeoff in the context of a new stylised fact we present: German banks are more likely to have financial connections when they face more similar risks --- potentially undermining the hedging role of financial connections and contributing to systemic risk. We find that such patterns are socially suboptimal, but can be explained by risk-shifting. Risk-shifting motivates banks to correlate their failures with their counterparties even though it creates systemic risk.

Keywords: Financial Networks, Systemic Risk, Risk-sharing, Limited Liability, Debtor Discipline, Homophily

Suggested Citation

Elliott, Matthew and Hazell, Jonathon and Georg, Co-Pierre, Systemic Risk-Shifting in Financial Networks (June 2, 2018). Available at SSRN: https://ssrn.com/abstract=2658249 or http://dx.doi.org/10.2139/ssrn.2658249

Matthew Elliott (Contact Author)

Cambridge University ( email )

Faculty of Economics
Austin Robinson Building Sidgwick Avenue
Cambridge, CB39DD
United Kingdom

Jonathon Hazell

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Co-Pierre Georg

University of Cape Town ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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