Systemic Risk-Shifting in Financial Networks

54 Pages Posted: 11 Sep 2015 Last revised: 11 Nov 2020

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: October 30, 2020

Abstract

Banks face different but potentially correlated risks from outside the financial system. Financial connections can share these risks, but they also create the means by which shocks can be propagated. We examine this tradeoff in the context of a new stylized fact we present: German banks are more likely to have financial connections when they face more similar risks. We develop a model that can rationalize such behavior. We argue that such patterns are socially suboptimal and raise systemic risk, 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 (October 30, 2020). 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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