Events

Finance Seminar

Author:

• Tan Wang
  Shanghai Jiao Tong University

• Hong Chen
  Shanghai Jiao Tong University

• David D. Yao
  Columbia University

We study the systemic risk of a financial system arising from its network interconnections. We build on Eisenberg and Noe (2001) and introduce dynamics into their static model. The dynamic model developed allows us to study the dynamics of bank defaults and financial crises. In contrast to the literature, we show that while the possibility of contagion is determined by interconnectedness of the financial network, whether a financial crisis can occur depends on the capitals of the banks in the system. We develop an index that forecasts the occurrence of a financial crisis. We then provide an intuitive measure of systemic risk. To illustrate the potential usefulness of our model, we provide an analysis of the system of twenty two German banks. We show how many of the banks are fundamentally weak, where the contagion effect may arise from and how significant the systemic risk is.