Abstract
The breakdown of short-term funding markets was a key feature of the global financial crisis of 2007/2008. Drawing on ideas from global games and network growth, we show how network topology interacts with the funding structure of financial institutions to determine system-wide crises. Bad news about a financial institution can lead others to lose confidence in it and their withdrawals, in turn, trigger problems across the interbank network. Once broken, credit relations take a long time to re-establish as a result of common knowledge of the equilibrium. Our findings shed light on public policy responses during and after the crisis.
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