Asset commonality, debt maturity and systemic risk

We develop a model in which asset commonality and short-term debt of banks interact to generate excessive systemic risk. Banks swap assets to diversify their individual risk. Two asset structures arise. In a clustered structure, groups of banks hold common asset portfolios and default together. In a...

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Bibliographic Details
Published in:Journal of financial economics 2012-06, Vol.104 (3), p.519-534
Main Authors: Allen, Franklin, Babus, Ana, Carletti, Elena
Format: Article
Language:English
Subjects:
Assets
Bank liquidity
Bank portfolios
Bank structure
Clustered and unclustered networks Interim information
Contagion
Debt repayment
Default
Maturity
Portfolio analysis
Risk
Risk management
Solvency
Studies
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Summary:We develop a model in which asset commonality and short-term debt of banks interact to generate excessive systemic risk. Banks swap assets to diversify their individual risk. Two asset structures arise. In a clustered structure, groups of banks hold common asset portfolios and default together. In an unclustered structure, defaults are more dispersed. Portfolio quality of individual banks is opaque but can be inferred by creditors from aggregate signals about bank solvency. When bank debt is short-term, creditors do not roll over in response to adverse signals and all banks are inefficiently liquidated. This information contagion is more likely under clustered asset structures. In contrast, when bank debt is long-term, welfare is the same under both asset structures.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2011.07.003