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Published October 2014 | Published
Journal Article Open

Financial Networks and Contagion

Abstract

We study cascades of failures in a network of interdependent financial organizations: how discontinuous changes in asset values (e.g., defaults and shutdowns) trigger further failures, and how this depends on network structure. Integration (greater dependence on counterparties) and diversification (more counterparties per organization) have different, nonmonotonic effects on the extent of cascades. Diversification connects the network initially, permitting cascades to travel; but as it increases further, organizations are better insured against one another's failures. Integration also faces trade-offs: increased dependence on other organizations versus less sensitivity to own investments. Finally, we illustrate the model with data on European debt cross-holdings.

Additional Information

© 2014 American Economic Association. Jackson gratefully acknowledges financial support from NSF grant SES-0961481 and grant FA9550-12-01-0411 from AFOSR and DARPA, and ARO MURI award No. W911NF-12-1-0509. All authors thank Microsoft Research New England Lab for research support. We thank Jean-Cyprien Héam, Scott Page, Gustavo Peralta, Ployplearn Ravivanpong, Alp Simsek, Alireza Tahbaz-Salehi, and Yves Zenou, as well as three referees and many seminar participants for helpful comments. The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.

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August 20, 2023
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