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Systemic RiskThe Dynamics of Modern Financial Systems$
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Prasanna Gai

Print publication date: 2013

Print ISBN-13: 9780199544493

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199544493.001.0001

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The Robust-Yet-Fragile Nature of Financial Systems

The Robust-Yet-Fragile Nature of Financial Systems

Chapter:
(p.8) (p.9) 2 The Robust-Yet-Fragile Nature of Financial Systems
Source:
Systemic Risk
Author(s):

Prasanna Gai

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780199544493.003.0002

This chapter develops an analytical model of contagion in financial networks with arbitrary degree structure. It illustrates, analytically and through numerical simulations, how the probability and potential impact of contagion is influenced by aggregate and idiosyncratic shocks, changes in network structure, and asset market liquidity. The findings suggest that financial systems exhibit a robust-yet-fragile tendency: while the probability of contagion may be low, the effects can be widespread when problems occur. The resilience of modern financial systems to large shocks prior to 2007 should not have been taken as a reliable guide to its future robustness.

Keywords:   contagion, network models, systemic risk, asset fire sales, liquidity risk, financial crises

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