Systemic Risk and Macroeconomic Fat Tails

Abstract

Abstract. We propose a mechanism for shock amplification that potentially can account for fat tails in the distribution of the growth rate of national output. We argue that extreme macroeconomic events, such as the Great Depression and the Great Recession, were preceded by significant turmoil in the banking system. We have developed a model of bank network formation and presented numerical simulations that show that, for the benchmark case, aggregate credit follows a random walk. When we introduce fire sales the model does not only produce larger variations in the growth of aggregate credit but also shows that there is an asymmetry between booms and busts that is also consistent with empirical evidence.

A review of global banking regulation under an assumption of complexity

“…The impact of systemic banking failures has been modelled by Bougheas et al . (2018) who reached the conclusion that macroeconomic crises were preceded by banking crises and in the absence of a stabilising mechanism, allowing for “fire sale” of assets, at the limit the whole banking system ran out of credit facilities. We have quantified the effect of banking crises on credit facilities using the gross domestic product (GDP) growth deviation methodology developed by Laeven & Valencia (2010) for financial crises in the United States, Ireland, Mexico, Thailand and Japan.…”