Fire Sales in a Model of Complexity
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Caballero_Fire sales.pdf
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561.39 KB
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Author(s)
Caballero, Ricardo J.
Simsek, Alp
Date Issued
November 2013
Journal
Journal of Finance
Publisher
American Finance Association/Wiley
Citation
Caballero, Ricardo J., and Alp Simsek. “Fire Sales in a Model of Complexity.” The Journal of Finance 68, no. 6 (November 12, 2013): 2549–2587.
Version
Original manuscript
Abstract
We present a model of financial crises that stem from endogenous complexity. We conceptualize complexity as banks' uncertainty about the financial network of cross exposures. As conditions deteriorate, cross exposures generate the possibility of a domino effect of bankruptcies. As this happens, banks face an increasingly complex environment since they need to understand a greater fraction of the financial network to assess their own financial health. Complexity dramatically amplifies banks' perceived counterparty risk, and makes relatively healthy banks reluctant to buy risky assets. The model also features a novel complexity externality.
MIT Department
Massachusetts Institute of Technology. Department of Economics
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Creative Commons Attribution-Noncommercial-Share Alike
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DOI of Published Version
https://doi.org/10.1111/jofi.12087
