
We develop a model that captures, at the same time, the temporal dynamics of single-firm credit risk and the contagion across banks via a network of obligations and common assets. In particular, we enrich the continuous-time modelling approach of default by accounting explicitly for the procyclical loop between asset prices and leverage. Contagion can spread well before any default occurs, through the value of the obligations held by counterparties. Moreover, the extent of procyclicality effects depends explicitly on the structure of both the interbank network and the asset bank network. We analyse the model in a simplified scenario of a densely connected core of banks and we carry out a systematic investigation of how procyclicality emerges from the multiplicative interplay of market illiquidity and tightness of capital requirements.
2000 General Economics, Econometrics and Finance, 2003 Finance, 10003 Department of Finance, Systemic risk, Procyclicality, Leverage, Market liquidity, Network models, 330 Economics, jel: jel:G28, jel: jel:G20
2000 General Economics, Econometrics and Finance, 2003 Finance, 10003 Department of Finance, Systemic risk, Procyclicality, Leverage, Market liquidity, Network models, 330 Economics, jel: jel:G28, jel: jel:G20
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