The contagion effect occurs when problems at one institution, particularly liquidity risk problems, damage other well-run institutions, as seen during the 2008 financial crisis. It is not related to positive correlation in FI returns (choice A), interest rate risk increasing credit and liquidity risks (choice B), computer viruses (choice D), or deposit insurance eliminating it (choice E).

Solved

The Contagion Effect

Question 30

Multiple Choice

The contagion effect

A) stems from the positive correlation in FI returns.
B) results when interest rate risk increases credit risk and liquidity risk exposures.
C) occurs when liquidity risk problems at bad banks damages well-run banks.
D) occurs when a computer virus infects the computerized electronics payments systems.
E) is completely eliminated by government provided deposit insurance against bank runs.

Correct Answer: