Confidence as a vector of financial contagion: how does it work, and how much does it matter?

Mardi | 2019-10-22
Salle des thèses 16h – 17h20

We provide a bank-run model in which confidence is proxied by the noise around the estimation by depositors of the distribution of the asset portfolio of their bank in t = 0. The probability that a bank i experiences a run in t = 1 depends on the realized returns of the other banks due to informational and balance sheet linkages between financial institutions. Low confidence is found to foster informational contagion, because it leads depositors to strongly revise their estimate of future bank portfolio return following bad returns. More surprisingly low confidence also enhances balance sheet contagion because the marginal impact of a loss from balance sheet linkages is higher when expected returns are low, implying that size matters more when confidence is low.