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| Author: | Ibragimov, R. Jaffee, D. Walden, J. |
| Title: | Diversification disasters |
| Journal: | Journal of Financial Economics
2011 : FEB, VOL. 99:2, p. 333-348 |
| Index terms: | financial crises financial institutions diversification risk models |
| Language: | eng |
| Abstract: | Significant externalities (hereafter as: ext/s.) and systemic risks arising from the interconnectedness of financial intermediaries' (herein as: intmds.) risk portfolios has been uncovered due to the recent financial crisis. This paper develops a model with the negative ext/s. arising due to intmeds.' actions to diversify in conditions optimal for individual intmeds., yet possibly suboptimal for society. It is shown that the ext/s. depend/s critically on the risks' distributional properties. The optimal social outcome (here as: soc-outm.) involves less risk-sharing, but also a lower probability for great collapses of intmeds. The exact conditions are derived under which risk-sharing restrictions create a preferable soc-outm. This paper's analysis has implications for regulating financial institutions and risk management. |
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