The economic and financial crises of the early 21st century (e.g. 2007 -- 2009 global financial turmoil) have made financial instability, which is induced by financial contagion, as one of the major concerns in the economics or financial field worldwide. In this paper we model a network of financial cross-holdings based on the classic Leontief input -- output framework, and study the effect of diversification of interbank exposures and interbank connection on the magnitude of financial contagions. We perform a comprehensive numerical experiment by varying the sequences of interbank exposures and interbank connections, the result shows that the diversification has negative influence on financial stability in some extent. Our study has significant implications on financial regulation and surveillance.
['Xian Cheng', 'Xinbo Sun', 'Stephen Shaoyi Liao', 'Zhongsheng Hua', 'Xiaolu Yang', 'M. Huang']
The Effect of Diversification on Financial Contagion