Contagion-Based Safety Premium in Bank Networks
59 Pages Posted: 16 Dec 2024
Abstract
We study the impact of network structures on ffnancial contagion and safety premiums in a model with collateralized lending and fully endogenized loan sizes. Safety premiums exist because safe assets help to deter the contagion of defaults. Only in bank networks containing directed cycles, can multiple equilibria featuring different sizes of loans emerge, and a small negative shock to collateral quality might disproportionately decrease the amount of interbank lending and increase safety premiums. A higher network density enhances both ffnancial contagion andrisk-sharing. Finally, safety premiums are higher in a core-periphery network than that in a complete network.
Keywords: Safety Premium, Network, Financial contagion, Collateral, Multiple Equilibria
Suggested Citation: Suggested Citation