Spring 2012 Seminar Series

DATE: April 26th
LOCATION: E51-335
TIME: 4:15pm
Reception immediately following in the ORC Conference Room (E40-106)

SPEAKER:
Daron Acemoglu

TITLE
Systemic risk and stability in financial networks

ABSTRACT
We provide a tractable framework for studying the relationship between the structure of financial networks and the extent of contagion and cascading failures. We argue that contagion in financial networks exhibits a form of phase transition as interbank connections increase. In particular, we show that as long as the magnitude and the number of negative shocks affecting financial institutions are sufficiently small, more “complete” interbank claims enhance the stability of the system. However, beyond a certain point, such interconnections start to serve as as mechanism for propagation of shocks and hence, lead to a more fragile financial system. We also show that financial networks that emerge in equilibriums may be more prone to contagion and systemic risks than those that the social planner would choose. The reason for this inefficiency is that banks do not internalize that their own failure has an adverse effect on othes. Finally, we show that the possibility of partial renegotiation of financial obligations leads to another form of phase transition: over a range of parameters, the structure of the financial network does not matter and the resources of the entire financial system can be used to provide equity to banks in distress. Beyond this range, however, the local connections of the financial networks determine the extent of contagion and cascading failures.