2018
DOI: 10.1007/s11403-018-0216-9
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Understanding the consequences of diversification on financial stability

Abstract: In this paper, we study the consequences of diversification on financial stability and social welfare using an agent based model that couples the real economy and a financial system. We validate the model against its ability to reproduce several stylized facts reported in real economies. We find that the risk of an isolated bank failure (i.e. idiosyncratic risk) is decreasing with diversification. In contrast, the probability of joint failures (i.e. systemic risk) is increasing with diversification which resul… Show more

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Cited by 6 publications
(3 citation statements)
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“…Others find that income diversification neither increases the return nor reduces the banks' risk (Acharya et al 2006;Hayden et al 2007). Under some circumstances, the relationship varies across different types of risks (e.g., Abedifar et al 2018;Akhigbe and Stevenson 2010;Carlson 2004;De Vries 2005;Elyasiani and Wang 2012;Banwo et al 2019). Hence, no apparent consensus has been reached on the diversification effects.…”
Section: Literature Reviewmentioning
confidence: 99%
“…Others find that income diversification neither increases the return nor reduces the banks' risk (Acharya et al 2006;Hayden et al 2007). Under some circumstances, the relationship varies across different types of risks (e.g., Abedifar et al 2018;Akhigbe and Stevenson 2010;Carlson 2004;De Vries 2005;Elyasiani and Wang 2012;Banwo et al 2019). Hence, no apparent consensus has been reached on the diversification effects.…”
Section: Literature Reviewmentioning
confidence: 99%
“…Their strength lies in the micro-interactions between individual decision-making agents (Tesfatsion 2006) each with their own characteristics; for example, businesses, households, or consumers, as well as spatial characteristics that geographically localize these interactions (Barthelemy 2016;Crosato et al 2018). These interactions can, in turn, be affected by banks' policies (Teglio et al 2012;Dosi et al 2013;Banwo et al 2019) and macroeconomics conditions (Cardaci 2018;Guilmi 2017;Mérő 2019). These agent-to-agent interactions produce complex (Jensen 2010), nonlinear effects such as tipping-points (Brock and Durlauf 2001;Harré et al 2019), boom-bust cycles (Geanakoplos et al 2012), and chaos Hommes 1998, Xin andHuang 2017), as well as the equilibrium dynamics predicted by classical models.…”
Section: Related Workmentioning
confidence: 99%
“…Moreover, financial crises incur substantial fiscal costs and output losses, averaging about 13.3 percent and 20 percent of GDP and can be as high as 55.1 percent and 98 percent of GDP, respectively (Valencia & Laeven, 2008). In 2008, Bank Century (formerly known as Bank CIC) was declared as a failing bank by The Financial System Stability Committee (KSSK) and rescued by the Government of Indonesia with an IDR 6.7 trillion bailout to prevent a spillover (Manurung & Moestafa, 2011 Financial regulators believe that diversification in banks can improve financial stability since it can minimize the likelihood of failure of an individual institution (Wagner, 2010), but the global financial crisis of 2007-2008 remained even though banks, especially large ones, had diversified their activities (Banwo et al, 2019). Banks begin to diversify their assets, funding, and revenue to face the increasing financial liberalization and innovation in the financial industry (Kim et al, 2020), without realizing that diversification can increase the spread of instability between institutions that will cause transmission of one institution's failure to other institutions, thereby increasing systemic risk and disrupting the stability of the financial system (Allen et al, 2012; Arinaminpathy et al, 2012; Banwo et al, 2019; De Jonghe, 2010; Kamani, 2019;Slijkerman et al, 2013;Wagner, 2010;Yang et al, 2019).…”
Section: Introductionmentioning
confidence: 99%