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Systemic RiskThe Dynamics of Modern Financial Systems$
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Prasanna Gai

Print publication date: 2013

Print ISBN-13: 9780199544493

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199544493.001.0001

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(p.1) 1 Introduction
Systemic Risk

Prasanna Gai

Oxford University Press

The introductory chapter describes the central thesis of the book, namely that understanding systemic risk in financial systems requires coming to terms with the consequences of network effects, funding liquidity risk, and fire sales of assets by banks in distress. These factors combine to generate ‘fat tails’ in the distribution of aggregate system losses. So while a financial system is robust to most shocks, when problems do arise, the effects can be catastrophic. The chapter also discusses how bank funding structure interacts with network topology, with ‘hysteresis’ resulting from the balance sheet adjustment that ensues when financial institutions are swayed by the opinions of their near neighbours. Recent progress in calibrating model banking systems to assist regulators with their financial stability mandates is also described.

Keywords:   contagion, systemic risk assessment, financial networks, balance sheet adjustment, systemic risk, macroprudential policy, financial crises

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