Credit chains and the propagation of financial distress

Arbeitspapier

The purpose of this paper is to analyze how shocks propagate through a network of firms that borrow from, and lend to, each other in a trade credit chain, and to quantify the effects of financial contagion across firms. I develop a theoretical model of financial contagion, in which the default of one firm may cause a chain reaction such that its creditors also get into financial difficulties, even though they are sound in the first place. I calibrate and simulate the model using US annual data over the period 1986-2004. At the microeconomic level, I find that, when customers of a sound firm are financially distressed, then this firm gets into financial difficulties with probability that ranges from 4.1% to 12.8% (depending on the business cycle and the underlying economic scenario). Looking at the macroeconomic level, I find that defaults on trade debts lower aggregate GDP by at least 0.4%. During the second half of the 90’s, these deadweight losses doubled and reached a high of 0.9% to 2.3% of GDP (depending on the underlying economic scenario) before the recession of 2001. The results of the simulations also suggest that financial contagion across businesses had been 25% higher during the last recession than during the recession of the early 90’s.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 573

Classification and Topics

• Classification: Wirtschaft ; Business Fluctuations; Cycles ; Financial Institutions and Services: Other ; Bankruptcy; Liquidation
• Subject: business fluctuations ; Financial contagion ; trade credit ; Lieferantenkredit ; Geldpolitische Transmission ; Konjunktur ; USA

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Boissay, Frédéric
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2006

Further information

• Handle: http://hdl.handle.net/10419/153007
• Last update: 10.03.2025, 11:45 AM CET