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Contagion in debt and collateral markets

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  • Chang, Jin-Wook
  • Chuan, Grace

Abstract

This paper investigates contagion in financial networks through collateralized debt and its effects on social welfare. Our model incorporates contagion through both counterparty debt exposures and endogenous collateral asset pricing. We find that collateral mitigates counterparty exposures and reduces social inefficiency when faced with negative shocks, but not always. We also show the importance of the interaction between the level of collateral and network structure as contagion can change dramatically depending on that interaction. The model also provides policy-relevant collateral-to-debt ratios (haircuts) to attain robust and fully insulated macroprudential states for any network and also the optimal collateral ratio to attain full insulation for a specific network.

Suggested Citation

  • Chang, Jin-Wook & Chuan, Grace, 2024. "Contagion in debt and collateral markets," Journal of Monetary Economics, Elsevier, vol. 148(C).
    • Handle: RePEc:eee:moneco:v:148:y:2024:i:c:s0304393224000539
    DOI: 10.1016/j.jmoneco.2024.103600
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    More about this item

    Keywords

    Collateral; Financial network; Fire sale; Systemic risk;
    All these keywords.

    JEL classification:

    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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