Risk transfer does not transfer systemic risk

Abstract

It had been believed that the risk of a bank going bankrupt is lessened in a straightfor-ward manner by transferring the risk of loan defaults. But the failure of American International Group in 2008 posed a more complex aspect of nancial contagion. This study presents an ex-tension of the asset network systemic risk model (ANWSER) to investigate whether credit default swaps mitigate or intensify the severity of nancial contagion. The empirical distribution of the number of bank bankruptcies is obtained with the extended model. Systemic capital bu er ratio is calculated from the distribution. The ratio quanti es the e ective loss absorbency capability of the entire nancial system to force back nancial contagion. The key nding is that the the risk transfer in an interbank network does not mitigate the severity of nancial contagion.