Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/289043 
Year of Publication: 
2020
Citation: 
[Journal:] Mathematics and Financial Economics [ISSN:] 1862-9660 [Volume:] 15 [Issue:] 1 [Publisher:] Springer [Place:] Berlin, Heidelberg [Year:] 2020 [Pages:] 59-101
Publisher: 
Springer, Berlin, Heidelberg
Abstract: 
Fire sales and default contagion are two of the main drivers of systemic risk in financial networks. While default contagion spreads via direct balance sheet exposures between institutions, fire sales describe iterated distressed selling of assets and their associated decline in price which impacts all institutions invested in these assets. That is, institutions are indirectly linked if they have overlapping asset portfolios. In this paper, we develop a model that helps us understand the joint effect of the two contagion channels and investigate structures of financial systems that promote or hinder the spread of an initial local shock. We first consider the contagion process for an explicitly given system and then derive our main results for random ensembles of systems whose macroscopic statistical characteristics of defining parameters are close to each other. In particular, we model direct exposures by means of a random graph. Our approach ensures robustness to local uncertainties and changes in the system. We characterize resilient and non-resilient system structures by criteria that can be used by regulators to assess system stability. Moreover, we provide explicit capital requirements that secure the financial system against the joint impact of fire sales and default contagion.
Subjects: 
Systemic risk
Financial contagion
Asset fire sales
Price-mediated contagion
Default contagion
Capital requirements
JEL: 
C02
E61
G01
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article
Document Version: 
Published Version

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