TY  - GEN
N1  - This version is the version of record. For information on re-use, please refer to the publisher?s terms and conditions.
TI  - Diversification and Financial Stability
Y1  - 2014/02/17/
AV  - public
EP  - 40
CY  - London, UK
A1  - Tasca, Paolo
A1  - Battiston, Stefano
T3  - SRC Discussion Paper
KW  - Naive Diversification
KW  -  Leverage
KW  -  Default Probability
N2  - The recent credit crisis of 2007/08 has raised a debate about the so-called knife-edge properties of financial markets. The paper contributes to the debate shedding light on the controversial relation between risk-diversification and financial stability. We model a financial network where assets held by borrowers to meet their obligations, include claims against other borrowers and securities exogenous to the network. The balance-sheet approach is conjugated with a stochastic setting and by a mean-field approximation the law of motion of the system's fragility is derived. We show that diversification has an ambiguous effect and beyond a certain levels elicits financial instability. Moreover, we find that risk-sharing restrictions create a socially preferable outcome. Our findings have significant implications for future policy recommendation.
ID  - discovery10186749
UR  - https://www.systemicrisk.ac.uk/publications/discussion-papers/diversification-and-financial-stability
PB  - Systemic Risk Centre, London School of Economics and Political Science
SN  - 2054-538X
ER  -