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Cambridge Endowment for Research in Finance (CERF)


Matt Elliott

Title of research: Endogenous Financial Networks: Efficient Modularity and Why Shareholders Prevent It (joint with Jonathon Hazell, MIT)

We study the implications for systemic risk of the classic conflict of interest between debt-holders and equity-holders. Through trades banks can diversify idiosyncratic risks and avoid failures following small shocks. However, the resulting financial interdependencies can create systemic risk and the possibility of multiple failures following large shocks. A social planner would resolve this trade-off by creating modular financial networks. However, we assume equity-holders control banks and show their exist trades away from the efficient networks that increase equity value. Finally, we ask which trades are profitable more generally, and whether these systematically exacerbate or ameliorate systemic risk?

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