Prasanna Gai, Nigel Jenkinson and Sujit Kapadia
In recent years, the financial system has been changing rapidly. At the same time, macroeconomic volatility has fallen in developed countries. The purpose of this paper is to…
Abstract
Purpose
In recent years, the financial system has been changing rapidly. At the same time, macroeconomic volatility has fallen in developed countries. The purpose of this paper is to examine how these developments may have affected the nature of systemic crises. The paper also aims to discuss how central banks and other financial regulators might respond to these developments with a clearer, more rigorous, operational framework for their systemic financial stability work.
Design/methodology/approach
The paper describes analytical models developed at the Bank of England to assess how recent developments may have affected the probability and potential impact of systemic financial crises. The results from these models help to shape the practical framework for the Bank's financial stability work.
Findings
The models suggest that financial innovation and integration, coupled with greater macroeconomic stability, have served to make systemic crises in developed countries less likely than in the past, but potentially more severe. Implementing a practical framework for financial stability work in response to this raises many formidable challenges.
Practical implications
If individuals are risk‐averse, the recent change in the profile of crises could lower welfare and would suggest that policymakers should place a higher premium on actions to monitor and mitigate systemic risk. The analysis also highlights the importance of differentiating the probability of risks from their potential impact.
Originality/value
The paper will be of interest to academics interested in systemic risk, central bankers, financial regulators, and financial market participants.
Details
Keywords
Pablo Estrada and Leonardo Sánchez-Aragón
Financial contagion refers to the propagation of shocks that can generate widespread failures. The authors apply a financial contagion model proposed by Elliott, Golub, and…
Abstract
Financial contagion refers to the propagation of shocks that can generate widespread failures. The authors apply a financial contagion model proposed by Elliott, Golub, and Jackson (2014) to a cross-shareholding network of firms in Ecuador. The authors use a novel dataset to study the potential channels for contagion. Although diversification is not high, results reveal enough conditions for a contagion event to occur. However, the low level of integration attenuates the effects of shocks. The authors run simulations affecting a particular firm at the time, and find that two firms coming from the finance and trade industry cause the highest contagion. In addition, when an entire industry receives a shock, trade and manufacturing industries contagion more companies than the rest. Finally, the model can assist policymakers to monitor the market and evaluate the fragility of the network in different scenarios.