Chapter 1 studies the interplay of network structure and imperfect information in financial contagion. Financial crisis may be started by fundamental liquidity shocks but contagion is triggered by precautionary actions of some market participants who have imperfect knowledge about the structure of the financial network. These uninformed market participants, depositors in our model, are uncertainty averse, i.e., they decide their withdrawing time as if their bank were in the worst network structure and were to be affected by the shocked bank through the financial linkage. Thus they rush to withdraw their deposits earlier than they should, which leads to another local bank failure, further endangering banks in other regions.

Chapter 2 studies the effects of diversification in int...[ Read more ]

Chapter 1 studies the interplay of network structure and imperfect information in financial contagion. Financial crisis may be started by fundamental liquidity shocks but contagion is triggered by precautionary actions of some market participants who have imperfect knowledge about the structure of the financial network. These uninformed market participants, depositors in our model, are uncertainty averse, i.e., they decide their withdrawing time as if their bank were in the worst network structure and were to be affected by the shocked bank through the financial linkage. Thus they rush to withdraw their deposits earlier than they should, which leads to another local bank failure, further endangering banks in other regions.

Chapter 2 studies the effects of diversification in interbank loans on the robustness of the financial networks. Specifically, I investigate how the degrees and patterns of diversification affect the extent of contagion of a financial system. Two patterns of diversification are numerically analyzed, one in which all banks expand their connection towards one direction, the other towards two directions symmetrically. We find that diversification enhances robustness largely by preventing contagion from happening in the first place. However, once contagion is unavoidable under large shocks, diversification has non-monotonic effect on the robustness, reducing the extent of contagion and then increasing it. This is true for both diversification patterns. Comparing across patterns, there are slight differences, but neither absolutely dominates the other.