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Heterogeneity risks and negative externality

Author

Listed:
  • Ba, Shusong
  • Li, Lu
  • Huang, Wenli
  • Yang, Chen

Abstract

Diversified institutions coexist in financial markets with different degrees of exposure and contribution to the systemic risk. Therefore, the identification and regulation of systemically important institutions are of great significance. This paper investigates the negative externality in a model where the heterogeneity risks of institutions interact and alienate the value of each other, with the bankruptcy risk acting as the kernel factor. The market negative externality increases when the bankruptcy risk is high. Furthermore, as an institution with a minimum tail index, the “first domino” dominates the bankruptcy risk of the market. The first domino accumulation and phantasm are prone to cause systemic crises. The market bankruptcy index decreases as the non-first domino participates in the risk sharing. Finally, we empirically study implications of the above findings for adjusting the market structure and managing risks, in the Chinese financial markets.

Suggested Citation

  • Ba, Shusong & Li, Lu & Huang, Wenli & Yang, Chen, 2020. "Heterogeneity risks and negative externality," Economic Modelling, Elsevier, vol. 87(C), pages 401-415.
    • Handle: RePEc:eee:ecmode:v:87:y:2020:i:c:p:401-415
    DOI: 10.1016/j.econmod.2019.08.016
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    Cited by:

    1. Antonio Cabrales & Piero Gottardi, 2024. "Network Formation and Heterogeneous Risks," CESifo Working Paper Series 11122, CESifo.

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    More about this item

    Keywords

    Externality; Diversification; Systemic crisis; First domino;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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