An economic model of contagion in interbank lending markets
AbstractThis paper considers the stability of a financial system in which heterogenous banks interact through a lending market. We analyse a discrete time model in which households and banks are located on a circular city. Households present banks with risky investment opportunities, which banks fund through deposits and interbank borrowing. In the event of bankruptcy, a bank defaults on its interbank loans potentially resulting in contagion and losses for other banks. Through simulation we examine the vulnerability of the financial system to systemic events, demonstrating the non-linear relationship between market concentration, shock severity and bankruptcies. The role and effect of regulatory actions such as reserve requirements, minimum bank capitalisation and constraints on the size of borrowing relationships, are considered in limiting these effects.
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Bibliographic InfoPaper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 11/06.
Date of creation: Nov 2010
Date of revision: Dec 2010
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Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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Other versions of this item:
- Dan Ladley, 2010. "Contagion and risk-sharing on the inter-bank market," Discussion Papers in Economics 11/10, Department of Economics, University of Leicester, revised Jan 2013.
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-11-27 (All new papers)
- NEP-BAN-2010-11-27 (Banking)
- NEP-CFN-2010-11-27 (Corporate Finance)
- NEP-FMK-2010-11-27 (Financial Markets)
- NEP-REG-2010-11-27 (Regulation)
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