NYU Economist to Study Contagion Among Financial Institutions, Role of Regulation Under Institute for New Economic Thinking Grant

Douglas Gale, a professor in New York University’s Department of Economics, will study contagion among financial institutions and the influence of prudential regulation on the transmission of shocks under a grant from the Institute for New Economic Thinking (INET).

Gale will be part of a research team that includes Antonio Guarino of University College London and Marco Cipriani of George Washington University.

INET was launched with a $50 million pledge from George Soros to promote changes in economic theory and practice through research grants, task force groups, academic partnerships, and conferences. The grant program, along with other INET initiatives, was created in response to the recent global economic crisis and has been designed to encourage and support new economic thinking.

This crisis demonstrates how the failure of one financial institution may lead to the toppling of other institutions. Gale, Guarino, and Cipriani plan to use INET’s funding to develop a new model of contagion, in which banks hold claims on other banks that are connected in a network. The model will analyze and test theoretical models, and highlight biases that can exacerbate or dampen the theoretical mechanism of financial contagion. Their work will be the first experimental study of contagion among financial institutions and will be used to evaluate the results of empirical studies based on market-generated data.

“The project by Guarino, Gale and Cipriani, addresses one of the aspects of the financial crisis that made for lots of news headlines but is still not thoroughly understood,” said Robert Johnson, executive director of INET. “Through this and other projects we are seeking to provide the knowledge that will keep cascading failures throughout the financial system from appearing in the future.”