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A Network Model of Financial System Resilience

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  • Kartik Anand
  • Prasanna Gai
  • Sujit Kapadia
  • Simon Brennan
  • Matthew Willison

Abstract

We examine the role of macroeconomic fluctuations, asset market liquidity, and network structure in determining contagion and aggregate losses in a financial system. Systemic instability is explored in a financial network comprising three distinct, but interconnected, sets of agents – domestic banks, international financial institutions, and firms. Calibrating the model to advanced country banking sector data, we obtain sensible aggregate loss distributions which are bimodal in nature. We demonstrate how systemic crises may occur and analyze how our results are influenced by firesale externalities and the feedback effects from curtailed lending in the macroeconomy. We also illustrate the resilience of our model financial system to stress scenarios with sharply rising corporate default rates and falling asset prices.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2011-051.

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Length: 38 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2011-051

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Keywords: Contagion; Financial crises; Network models; Systemic risk;

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  1. Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
  2. Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
  3. Aikman, David & Alessandri, Piergiorgio & Eklund, Bruno & Gai, Prasanna & Kapadia, Sujit & Martin, Elizabeth & Mora, Nada & Sterne, Gabriel & Willison, Matthew, 2009. "Funding liquidity risk in a quantitative model of systemic stability," Bank of England working papers 372, Bank of England.
  4. Piergiorgio Alessandri & Prasanna Gai & Sujit Kapadia & Nada Mora & Claus Puhr, 2009. "Towards a Framework for Quantifying Systemic Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 5(3), pages 47-81, September.
  5. Elsinger, Helmut & Lehar, Alfred & Summer, Martin, 2005. "Using Market Information for Banking System Risk Assessment," MPRA Paper 817, University Library of Munich, Germany.
  6. Horst, Ulrich, 2007. "Stochastic cascades, credit contagion, and large portfolio losses," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 25-54, May.
  7. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  8. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
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