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Heterogeneity, Correlations And Financial Contagion

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  • FABIO CACCIOLI

    (Santa Fe Institute, 1399 Hyde Park Road, Santa Fe, NM 87501, USA)

  • THOMAS A. CATANACH

    (University of Notre Dame, Notre Dame, IN 46556, USA)

  • J. DOYNE FARMER

    (Santa Fe Institute, 1399 Hyde Park Road, Santa Fe, NM 87501, USA)

Abstract

We consider a model of contagion in financial networks recently introduced in Gai, P. and Kapadia, S. [Contagion in financial networks, Proc. R. Soc. A 466(2120) (2010) 2401–2423], and we characterize the effect of a few features empirically observed in real networks on the stability of the system. Notably, we consider the effect of heterogeneous degree distributions, heterogeneous balance sheet size and degree correlations between banks. We study the probability of contagion conditional on the failure of a random bank, the most connected bank and the biggest bank, and we consider the effect of targeted policies aimed at increasing the capital requirements of a few banks with high connectivity or big balance sheets. Networks with heterogeneous degree distributions are shown to be more resilient to contagion triggered by the failure of a random bank, but more fragile with respect to contagion triggered by the failure of highly connected nodes. A power law distribution of balance sheet size is shown to induce an inefficient diversification that makes the system more prone to contagion events. A targeted policy aimed at reinforcing the stability of the biggest banks is shown to improve the stability of the system in the regime of high average degree. Finally, disassortative mixing, such as that observed in real banking networks, is shown to enhance the stability of the system.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal Advances in Complex Systems.

Volume (Year): 15 (2012)
Issue (Month): su ()
Pages: 1250058-1-1250058-15

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Handle: RePEc:wsi:acsxxx:v:15:y:2012:i:su:p:1250058-1-1250058-15

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Keywords: Contagion; network models; systemic risk;

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  1. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(6), pages 2033-2060, June.
  2. Iori, G. & Masi, G. D. & Precup, O. V. & Gabbi, G. & Caldarelli, G., 2005. "A network analysis of the Italian oversight money market," Working Papers, Department of Economics, City University London 05/05, Department of Economics, City University London.
  3. Michele Manna & Carmela Iazzetta, 2009. "The topology of the interbank market: developments in Italy since 1990," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 711, Bank of Italy, Economic Research and International Relations Area.
  4. Edson Bastos e Santos & Rama Cont, 2010. "The Brazilian Interbank Network Structure and Systemic Risk," Working Papers Series, Central Bank of Brazil, Research Department 219, Central Bank of Brazil, Research Department.
  5. Co-Pierre Georg, 2010. "The effect of the interbank network structure on contagion and financial stability," Global Financial Markets Working Paper Series 12-2010, Friedrich-Schiller-University Jena.
  6. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "Network topology of the interbank market," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 4(6), pages 677-684.
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Cited by:
  1. Leonidov, A. & Rumyantsev, E., 2013. "Russian Interbank Systemic Risks Assessment from the Network Topology Point of View," Journal of the New Economic Association, New Economic Association, New Economic Association, vol. 19(3), pages 65-80.

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