Search this site
by Faculty Name
by Publication Type
by Academic Area
HKS Faculty Research
FRC User's Guide
Submit New & Edit Current Publication Citations
Browse Academic Area
Academic Area Results
Frank Plumpton Ramsey Professor of Political Economy
HKS Faculty Research Working Paper Series
Tran, Ngoc-Khanh, Thao Vuong, and Richard Zeckhauser. "Loss Sequencing in Banking Networks: Threatened Banks as Strategic Dominoes." HKS Faculty Research Working Paper Series RWP16-030, August 2016.
We demonstrate in a stylized banking network that a single large loss has the potential to leave markedly different impacts on the financial system than does a sequence of moderate losses of the same cumulative magnitude. Loss sequencing matters because banks make strategic bailout decisions based on their myopic assessment of losses, yet these decisions are highly consequential to subsequent decisions and eventual losses at other banks in the network. In particular, the network mechanism enables banks to choose to bail out their creditors after every moderate loss incurred in a sequence, while walking away from the creditors should they experience a single large loss. Government policy can force threatened banks to liquidate or sell themselves or, at the opposite pole, can bail out some such banks or overlook their threatened status. The former policy would concentrate a string of losses into a single large event; the latter could prevent a massive single loss at the expense of multiple subsequent smaller losses. As this analysis shows, either policy could prove optimal depending on identifiable circumstances. These findings have important implications for on-going policy debates that emanated from the 2008 meltdown.
Copyright © 2017 The President and Fellows of Harvard College