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Systemic risk in a network model of interbank markets with central bank activity

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  • Co-Pierre Georg

    ()
    (Graduate School "Global Financial Markets - Stability and Change", Friedrich-Schiller-Universität Jena)

  • Jenny Poschmann

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

Abstract

The breakdown of the interbank money markets in the face of the recent financial crisis has forced central banks and governments to take extraordinary measures to sustain financial stability. In this paper we investigate which influence central bank activity has on interbank markets. In our model, banks optimize a portfolio of risky investments and riskless excess reserves according to their risk and liquidity preferences. They are linked via interbank loans and face a stochastic supply of household deposits. We then introduce a central bank into the model and show that central bank activity enhances financial stability. We model the default of a large bank and analyse the resulting contagion effects. This is compared to a common shock that hits banks who have invested in similiar assets. Our results indicate that common shocks are not subordinate to contagion effects, but are instead the greater threat to systemic stability.

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Bibliographic Info

Paper provided by Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics in its series Jena Economic Research Papers with number 2010-033.

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Date of creation: 01 Jun 2010
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Handle: RePEc:jrp:jrpwrp:2010-033

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Keywords: systemic risk; interbank markets; monetary policy; contagion; common shocks;

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Citations

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Cited by:
  1. G. Wims & D. Martens & M. De Backer, 2011. "Network Models of Financial Contagion: A Definition and Literature Review," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 11/730, Ghent University, Faculty of Economics and Business Administration.
  2. Paolo Giudici & Alessandro Spelta, 2013. "Graphical network models for international financial flows," DEM Working Papers Series 052, University of Pavia, Department of Economics and Management.
  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.

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