Systemic Risk and Financial Contagion

Abstract

It is widely acknowledged now, by many financial and macroeconomists, that in the past, only little attention has been paid to “systemic risk” and “financial contagion”. Rochet and Tirole point out that the ”anxiety about systemic risk is perhaps strongest among bank executives and regulators“. Galati and Moessner state that ”there has been a fundamental lack of understanding of system-wide risk“. Battiston et al. confirm the latter statement by saying that the ”recent financial crisis has shown that systemic risk has been dramatically underestimated“. Fouque and Langsam emphasis this fact when they say that the ”[r]ecent history has shown us not only the enormous cost of a systemic crisis but also how woefully unprepared and ill-equipped governments and private markets have been to prevent systemic crisis or minimize its impact“. According to Geanakoplos et al. Macroeconomists were completely surprised by the financial crisis of 2007-2009. Up until then they had concentrated on macroeconomics with a capital M: global imbalances, interest rates, monetary policy“. Therefore, as Martınez-Jaramillo et al. put it, the ”understanding of systemic risk is of central importance for maintaining financial stability“.

Keywords: systemic risk, financial stability, network theory

JEL Classification: E03, G01