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A network model of financial system resilience

  • Anand, Kartik


    (Technische Universitat Berlin)

  • Gai, Prasanna


    (Department of Economics, University of Auckland and National University of Singapore, Risk Management Institute)

  • Kapadia, Sujit


    (Bank of England)

  • Brennan, Simon


    (Bank of England)

  • Willison, Matthew


    (Bank of England)

We examine the role of macroeconomic fluctuations, asset market liquidity, and network structure in determining contagion and aggregate losses in a stylised financial system. Systemic instability is explored in a financial network comprising three distinct, but interconnected, sets of agents - domestic banks, overseas banks, and firms. Calibrating the model to advanced country banking sector data, this preliminary model generates broadly sensible aggregate loss distributions which are bimodal in nature. We demonstrate how systemic crises may occur and analyse how our results are influenced by fire-sale 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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Paper provided by Bank of England in its series Bank of England working papers with number 458.

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Length: 41 pages
Date of creation: 20 Jul 2012
Date of revision:
Handle: RePEc:boe:boeewp:0458
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  1. 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.
  2. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  3. Horst, Ulrich, 2007. "Stochastic cascades, credit contagion, and large portfolio losses," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 25-54, May.
  4. Elsinger, Helmut & Lehar, Alfred & Summer, Martin, 2005. "Using Market Information for Banking System Risk Assessment," MPRA Paper 817, University Library of Munich, Germany.
  5. 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.
  6. Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
  7. 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.
  8. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
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