Journal
AMERICAN ECONOMIC REVIEW
Volume 105, Issue 2, Pages 564-608Publisher
AMER ECONOMIC ASSOC
DOI: 10.1257/aer.20130456
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This paper argues that the extent of financial contagion exhibits a form of phase transition: as long as the magnitude of negative shocks affecting financial institutions are sufficiently small, a more densely connected financial network (corresponding to a more diversified pattern of interbank liabilities) enhances financial stability. However, beyond a certain point, dense interconnections serve as a mechanism for the propagation of shocks, leading to a more fragile financial system. Our results thus highlight that the same factors that contribute to resilience under certain conditions may function as significant sources of systemic risk under others.
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