Endogenous Risk-Exposure and Systemic Instability Chong Shu - - PowerPoint PPT Presentation
Endogenous Risk-Exposure and Systemic Instability Chong Shu University of Southern California FDIC-JFSR Annual Bank Conference September 13, 2019 Do highly connected financial networks contribute to systemic stability or systemic fragility?
University of Southern California FDIC-JFSR Annual Bank Conference September 13, 2019
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Connected-Stability:
mechanism against shocks.
(Allen and Gale, 2000; Freixas et al., 2000)
Connected-Fragility:
propagation mechanism to spread the loss. (Acemoglu et al., 2015)
Literature assumed exogenous shocks. They studied how shocks are propagated.
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However, banks’ exposure to which particular shock is an endogenous choice variable.
In this paper, I endogenize banks’ ex-ante choice of risk exposure. The standard intuition about the stabilizing effect of financial networks reverses with endogenous risk- taking.
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Bank 1 Bank 2 Bank 4 Bank 3 retail depositors Risky Project: Success or Failure
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Lemma
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When bank fails (with probability ) Bank will choose safe project if When bank succeeds (with probability )
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Proposition
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– network completeness
Proposition
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– network completeness
Proposition
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– Central Clearing Counterparties
Proposition
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– Central Clearing Counterparties
Proposition
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chongshu@usc.edu
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