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Financial contagion in inter-bank networks with overlapping portfolios

Author

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  • Peilong Shen

    (Shanxi University of Finance and Economics)

  • Zhinan Li

    (Shanxi University of Finance and Economics)

Abstract

By considering overlapping portfolios among financial institutions, we construct a financial contagion model for inter-bank networks with two channels of contagion: counter-party risk and common asset holdings risk. Based on the model, we verify the contribution of overlapping portfolios to systemic risk contagion and further analyse how the degree of diversification and initial shock affect the probability, extent and loss degree of contagion in different network structures. The results show that as the degree of diversification increases, the probability, extent and loss degree show overall inverted U-shaped tendencies. Different from the existing research that focuses only on a single channel of risk contagion, we find that the risk contagion is significant because of the combined effect of counter-party risk and common asset holdings risk, even though there is little portfolio overlap. Additionally, we study the core–periphery network to investigate the particularity of systematically important financial institutions and the feedback effect in financial networks when banks proactively reduce the exposure of depreciating assets.

Suggested Citation

  • Peilong Shen & Zhinan Li, 2020. "Financial contagion in inter-bank networks with overlapping portfolios," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 15(4), pages 845-865, October.
    • Handle: RePEc:spr:jeicoo:v:15:y:2020:i:4:d:10.1007_s11403-019-00274-1
    DOI: 10.1007/s11403-019-00274-1
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    Cited by:

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    More about this item

    Keywords

    Systemic risk; Contagion; Financial network; Overlapping portfolios;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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