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The effect of the interbank network structure on contagion and financial stability

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  • Co-Pierre Georg

    ()
    (School of Economics and Business Administration, Friedrich-Schiller-University Jena)

Abstract

In the wake of the financial crisis it has become clear that there is a need for macroprudential oversight in addition to the existing microprudential banking supervision. One of the lessons from the crisis is that the network structure of the banking system has to be taken into account to assess systemic risk. There exists, however, no analysis on the influence of the network topology on contagion in financial networks. This paper therefore compares contagion in Barabási-Albert (scale-free) with Watts-Strogatz (small-world) and random networks. A network model of banks, a firm- and household-sector as well as a central bank is used. Banks optimize a portfolio of risky investments and risk-free excess reserves according to their risk and liquidity preferences. They form a network via interbank loans and face a stochastic supply of household deposits. Contagion effects from the default of a large bank are studied in different network topologies. The results indicate that contagion is more severe in random and scale-free networks than in small-world networks. This situation changes when the central bank is not active in which case small-world networks are less stable than scale-free and random networks. It is also shown that interbank liquidity above a certain threshold leads to endogenous instability, regardless of the network topology. The results further indicate that network heterogeneity does not contribute to financial instability.

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File URL: http://pubdb.wiwi.uni-jena.de/pdf/wp_hlj12-2010.pdf
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Bibliographic Info

Paper provided by Friedrich-Schiller-University Jena in its series Global Financial Markets Working Paper Series with number 12-2010.

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Date of creation: 05 Oct 2010
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Handle: RePEc:hlj:hljwrp:12-2010

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Web page: http://www.gfinm.de

Related research

Keywords: systemic risk; contagion; interbank markets; network models;

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References

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  1. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
  2. Galbiati, Marco & Soramaki, Kimmo, 2008. "An agent-based model of payment systems," Bank of England working papers 352, Bank of England.
  3. Kavonius, Ilja Kristian & Castrén, Olli, 2009. "Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area," Working Paper Series 1124, European Central Bank.
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Cited by:
  1. Luiz A. Pereira da Silva & Adriana Soares Sales & Wagner Piazza Gaglianone, 2012. "Financial Stability in Brazil," Working Papers Series 289, Central Bank of Brazil, Research Department.
  2. Fabio Caccioli & Thomas A. Catanach & J. Doyne Farmer, 2011. "Heterogeneity, correlations and financial contagion," Papers 1109.1213, arXiv.org.
  3. Sandoval, Leonidas Junior, 2013. "To lag or not to lag? How to compare indices of stock markets that operate at different times," Insper Working Papers wpe_319, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  4. Fischer, Thomas & Riedler, Jesper, 2013. "Prices, debt and market structure in an agent-based model of the financial market," ZEW Discussion Papers 12-045 [rev.], ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  5. Fabio Caccioli & Munik Shrestha & Cristopher Moore & J. Doyne Farmer, 2012. "Stability analysis of financial contagion due to overlapping portfolios," Papers 1210.5987, arXiv.org.
  6. Marc de Kamps & Daniel Ladley & Aistis Simaitis, 2012. "Heterogeneous Beliefs in Over-The-Counter Markets," Discussion Papers in Economics 13/03, Department of Economics, University of Leicester, revised Sep 2013.

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