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Market procyclicality and systemic risk


Battiston, Stefano; Tasca, Paolo (2016). Market procyclicality and systemic risk. Quantitative Finance, 16(8):1219-1235.

Abstract

We develop a model that captures, at the same time, the temporal dynamics of single-firm credit risk and the contagion across banks via a network of obligations and common assets. In particular, we enrich the continuous-time modelling approach of default by accounting explicitly for the procyclical loop between asset prices and leverage. Contagion can spread well before any default occurs, through the value of the obligations held by counterparties. Moreover, the extent of procyclicality effects depends explicitly on the structure of both the interbank network and the asset bank network. We analyse the model in a simplified scenario of a densely connected core of banks and we carry out a systematic investigation of how procyclicality emerges from the multiplicative interplay of market illiquidity and tightness of capital requirements.

Abstract

We develop a model that captures, at the same time, the temporal dynamics of single-firm credit risk and the contagion across banks via a network of obligations and common assets. In particular, we enrich the continuous-time modelling approach of default by accounting explicitly for the procyclical loop between asset prices and leverage. Contagion can spread well before any default occurs, through the value of the obligations held by counterparties. Moreover, the extent of procyclicality effects depends explicitly on the structure of both the interbank network and the asset bank network. We analyse the model in a simplified scenario of a densely connected core of banks and we carry out a systematic investigation of how procyclicality emerges from the multiplicative interplay of market illiquidity and tightness of capital requirements.

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5 citations in Web of Science®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2016
Deposited On:06 Jan 2017 14:35
Last Modified:19 Aug 2018 06:15
Publisher:Taylor & Francis
ISSN:1469-7688
OA Status:Closed
Publisher DOI:https://doi.org/10.1080/14697688.2015.1123817
Related URLs:http://www.tandfonline.com/doi/full/10.1080/14697688.2015.1123817 (Publisher)
Other Identification Number:merlin-id:13911
Project Information:
  • : FunderFP7
  • : Grant ID255987
  • : Project TitleFOC-II - Forecasting Financial Crises
  • : FunderSNSF
  • : Grant IDPP00P1_144689
  • : Project TitleFinancial Networks and Systemic Risk

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