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Heterogeneity, correlations and financial contagion

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  • Fabio Caccioli
  • Thomas A. Catanach
  • J. Doyne Farmer

Abstract

We consider a model of contagion in financial networks recently introduced in the literature, 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.

Suggested Citation

  • Fabio Caccioli & Thomas A. Catanach & J. Doyne Farmer, 2011. "Heterogeneity, correlations and financial contagion," Papers 1109.1213, arXiv.org.
  • Handle: RePEc:arx:papers:1109.1213
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    References listed on IDEAS

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    1. Edson Bastos e Santos & Rama Cont, 2010. "The Brazilian Interbank Network Structure and Systemic Risk," Working Papers Series 219, Central Bank of Brazil, Research Department.
    2. Michele Manna & Carmela Iazzetta, 2009. "The topology of the interbank market: developments in Italy since 1990," Temi di discussione (Economic working papers) 711, Bank of Italy, Economic Research and International Relations Area.
    3. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
    4. 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.
    5. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    6. Iori, Giulia & De Masi, Giulia & Precup, Ovidiu Vasile & Gabbi, Giampaolo & Caldarelli, Guido, 2008. "A network analysis of the Italian overnight money market," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 259-278, January.
    7. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "Network topology of the interbank market," Quantitative Finance, Taylor & Francis Journals, vol. 4(6), pages 677-684.
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    Citations

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    Cited by:

    1. Levan Efremidze & John Rutledge & Thomas D. Willett, 2016. "Capital Flow Surges As Bubbles: Behavioral Finance And Mckinnon’S Over-Borrowing Syndrome Extended," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(02), pages 1-27, June.
    2. Cameron Hepburn & Eric Beinhocker & J. Doyne Farmer & Alexander Teytelboym, 2014. "Resilient and Inclusive Prosperity within Planetary Boundaries," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 22(5), pages 76-92, September.
    3. Opeoluwa Banwo & Fabio Caccioli & Paul Harrald & Francesca Medda, 2016. "The Effect Of Heterogeneity On Financial Contagion Due To Overlapping Portfolios," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 19(08), pages 1-20, December.
    4. repec:spr:jeicoo:v:13:y:2018:i:2:d:10.1007_s11403-017-0188-1 is not listed on IDEAS
    5. Leonardo Bargigli & Giovanni di Iasio & Luigi Infante & Fabrizio Lillo & Federico Pierobon, 2015. "Interbank markets and multiplex networks: centrality measures and statistical null models," Papers 1501.05751, arXiv.org.
    6. Tao Xu & Jianmin He & Shouwei Li, 2016. "Multi-Channel Contagion In Dynamic Interbank Market Network," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 19(06n07), pages 1-25, September.
    7. Leventides, John & Loukaki, Kalliopi & Papavassiliou, Vassilios G., 2019. "Simulating financial contagion dynamics in random interbank networks," Journal of Economic Behavior & Organization, Elsevier, vol. 158(C), pages 500-525.
    8. Paolo Bartesaghi & Michele Benzi & Gian Paolo Clemente & Rosanna Grassi & Ernesto Estrada, 2019. "Risk-dependent centrality in economic and financial networks," Papers 1907.07908, arXiv.org, revised Jul 2019.
    9. Grant, Everett & Yung, Julieta, 2017. "The Double-Edged Sword of Global Integration: Robustness, Fragility & Contagion in the International Firm Network," Globalization Institute Working Papers 313, Federal Reserve Bank of Dallas.
    10. repec:spr:jeicoo:v:13:y:2018:i:1:d:10.1007_s11403-017-0199-y is not listed on IDEAS
    11. Roger Koppl & Stuart Kauffman & Giuseppe Longo & Teppo ­­­felin, 2015. "Economics for a creative world," Post-Print hal-01415131, HAL.
    12. Fricke, Daniel & Lux, Thomas, 2012. "Core-periphery structure in the overnight money market: Evidence from the e-MID trading platform," Kiel Working Papers 1759, Kiel Institute for the World Economy (IfW).
    13. repec:eee:jeborg:v:162:y:2019:i:c:p:329-346 is not listed on IDEAS
    14. Yuanying Guan & Micah Pollak, 2016. "Contagion In Heterogeneous Financial Networks," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 19(01n02), pages 1-25, February.
    15. repec:eee:ecmode:v:76:y:2019:i:c:p:281-292 is not listed on IDEAS
    16. repec:eee:phsmap:v:520:y:2019:i:c:p:458-480 is not listed on IDEAS
    17. Richard Bookstaber & Mark Paddrik & Brian Tivnan, 2018. "An agent-based model for financial vulnerability," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 13(2), pages 433-466, July.

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