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Balance Sheet Interlinkages And Macro-Financial Risk Analysis In The Euro Area

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Executive Summary

The financial crisis has highlighted the need for models that can identify counterparty risk exposures and shock transmission processes at the systemic level. The authors use the euro area financial accounts (flow of funds) data to construct a sector-level network of bilateral balance sheet exposures and show how local shocks can propagate throughout the network and affect the balance sheets in other, even seemingly remote, parts of the financial system. They then use the contingent claims approach to extend this accounting-based network of interlinked exposures to risk-based balance sheets which are sensitive to changes in leverage and asset volatility.

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