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A network model of financial system resilience

Listed author(s):
  • 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
Handle: RePEc:boe:boeewp:0458
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  2. Francis A. Longstaff & Arvind Rajan, 2006. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," NBER Working Papers 12210, National Bureau of Economic Research, Inc.
  3. Til Schuermann & Samuel Hanson, 2004. "Estimating probabilities of default," Staff Reports 190, Federal Reserve Bank of New York.
  4. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
  5. Antonella Foglia, 2009. "Stress Testing Credit Risk: A Survey of Authorities' Aproaches," International Journal of Central Banking, International Journal of Central Banking, vol. 5(3), pages 9-45, September.
  6. Goetz von Peter, 2007. "International banking centres: a network perspective," BIS Quarterly Review, Bank for International Settlements, December.
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  9. 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.
  10. 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.
  11. Allen, Franklin & Gale, Douglas, 1998. "Financial Contagion," Working Papers 98-33, C.V. Starr Center for Applied Economics, New York University.
  12. Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December.
  13. Mark Mitchell & Lasse Heje Pedersen & Todd Pulvino, 2007. "Slow Moving Capital," NBER Working Papers 12877, National Bureau of Economic Research, Inc.
  14. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
  15. Elsinger, Helmut & Lehar, Alfred & Summer, Martin, 2005. "Using Market Information for Banking System Risk Assessment," MPRA Paper 817, University Library of Munich, Germany.
  16. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
  17. 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.
  18. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-1242, September.
  19. Franklin Allen & Douglas Gale, 2005. "From Cash-in-the-Market Pricing to Financial Fragility," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 535-546, 04/05.
  20. Horst, Ulrich, 2007. "Stochastic cascades, credit contagion, and large portfolio losses," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 25-54, May.
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  22. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
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