Risk-Sharing and the Creation of Systemic Risk

65 Pages Posted: 22 Sep 2020

See all articles by Viral V. Acharya

Viral V. Acharya

Professor; New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Aaditya Iyer

affiliation not provided to SSRN

Rangarajan K. Sundaram

New York University (NYU) - Department of Finance

Date Written: September 1, 2020

Abstract

We address the paradox that financial innovations aimed at risk-sharing appear to have made the world riskier. Financial innovations facilitate hedging idiosyncratic risks among agents; however, aggregate risks can be hedged only with liquid assets. When risk-sharing is primitive, agents selfhedge and hold more liquid assets; this buffers aggregate risks, resulting in few correlated failures compared to when there is greater risk sharing. We apply this insight to build a model of a clearinghouse to show that as risk-sharing improves, aggregate liquidity falls but correlated failures rise. Public liquidity injections, for example, in the form of a lender-of-last-resort can reduce this systemic risk ex post, but induce lower ex-ante levels of private liquidity, which can in turn aggravate welfare costs from such injections.

JEL Classification: G21, G22, G31

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Iyer, Aaditya and Sundaram, Rangarajan K., Risk-Sharing and the Creation of Systemic Risk (September 1, 2020). Available at SSRN: https://ssrn.com/abstract=3696349 or http://dx.doi.org/10.2139/ssrn.3696349

Viral V. Acharya (Contact Author)

Professor ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
2129980354 (Phone)
2129954256 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
2129980354 (Phone)
2129954256 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Aaditya Iyer

affiliation not provided to SSRN

Rangarajan K. Sundaram

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0308 (Phone)
212-995-4233 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
8
Abstract Views
223
PlumX Metrics