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Connectedness and ContagionProtecting the Financial System from Panics$
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Hal S. Scott

Print publication date: 2016

Print ISBN-13: 9780262034371

Published to MIT Press Scholarship Online: January 2017

DOI: 10.7551/mitpress/9780262034371.001.0001

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The Concept of Connectedness

The Concept of Connectedness

(p.3) 1 The Concept of Connectedness
Connectedness and Contagion

Hal S. Scott

The MIT Press

This chapter discusses the first of the three components of systemic risk: connectedness. Asset connectedness is the concern that the failure of one financial institution will provoke a chain reaction of failures by other financial institutions with direct credit exposures to the failed institutions. Liability connectedness refers to the connection between the providers and recipients of short-term funding, whereby if a funding institution fails, the failure of its dependent recipient institutions will also result. Neither asset connectedness nor liability connectedness defaults were a problem during the 2008 financial crisis. The losses imposed on firms by Lehman Brothers were not large enough to push them into bankruptcy. Moreover, liability connectedness defaults were not a problem during the crisis, as Lehman, nor other financial institutions, were an important source of short-term funding for other financial institutions.

Keywords:   asset connectedness, liability connectedness, financial institution, credit exposure, short-term funding, defaults, financial crisis, systemic risk

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