Information contagion and systemic risk

Abstract

We examine the effect of ex-post information contagion on the ex-ante level of systemic risk defined as the probability of joint bank default. Because of counterparty risk or common exposures, bad news about one bank reveals valuable information about another bank, triggering information contagion. When banks are subject to common exposures, information contagion induces small adjustments to bank portfolios and therefore increases overall systemic risk. When banks are subject to counterparty risk, by contrast, information contagion induces a large shift toward more prudential portfolios, thereby reducing systemic risk.

Financial Contagion in Networks

“…where 1 fv i <lg denotes (with a slight abuse of notation) the vector of indicator functions taking value 1 if v i < l and 0 otherwise, for i = 1; ::; N: We see from (3) that, as long as > 0, the value v of the …rms' assets is now a discontinuous function of r, that jumps whenever some …rm defaults. Moreover, v is determined as a …xed point of the map de…ned by (3), since the level of v also determines whether a …rm is solvent or not; if insolvent a …rm has to pay the additional default cost, which in turn a¤ects the value of v, and so on. To see this, take N = 2; A = " 0:7 0:3 0:3 0:7 # ; R = 1 if no shock hits and r i = 0:5 if a shock hits, l = 0:8 and = 0:5.…”

“…As we have seen, the approach in CGV and EGJ looks at the presence of linkages among the assets of the di¤erent …rms given by cross holdings of claims to the returns on projects. 3 In contrast, Glasserman and Young (2015) [GY] and Acemoglu, Ozdaglar and Tahbaz-Salehi (2014) [AOT] consider linkages among both assets and liabilities of …rms, arising from mutual lending and borrowing relationships among them, via standard debt contracts. In this case a ij denotes the payments due from …rm i to …rm j.…”

“…in the subsequent period. Also, a limited liability constraint could be added in (3) with no change in the substance of the results. 3 These claims could also be given by derivatives whose return is a more general, non linear function of the yield of these projects.…”

“…Also, a limited liability constraint could be added in (3) with no change in the substance of the results. 3 These claims could also be given by derivatives whose return is a more general, non linear function of the yield of these projects. 4 Such an environment is also considered by Shin (2009) to study the e¤ects of changes in credit volumes.…”

“…Informational contagion between banks has been explored in settings that do not call for an explicit network structure. One example is the paper by Ahnert and Georg (2012), in which the release of bad information about one bank provides information about other banks, because of common asset holdings and common counterparty exposures. The paper by Ahnert and Bertsch (2014) makes use of a di¤erent type of contagion, the "wake up call.…”