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Bank Networks: Contagion, Systemic Risk and Prudential Policy

Listed author(s):
  • Inaki Aldasoro
  • Domenico Delli Gatti
  • Ester Faia

We present a network model of the interbank market in which optimizing risk averse banks lend to each other and invest in non-liquid assets. Market clearing takes place through a tâtonnement process which yields the equilibrium price, while traded quantities are determined by means of a matching algorithm. We compare three alternative matching algorithms: maximum entropy, closest matching and random matching. Contagion occurs through liquidity hoarding, interbank interlinkages and fire sale externalities. The resulting network configurations exhibits a core-periphery structure, dis-assortative behavior and low clustering coefficient. We measure systemic importance by means of network centrality and input-output metrics and the contribution of systemic risk by means of Shapley values. Within this framework we analyze the effects of prudential policies on the stability/efficiency trade-off. Liquidity requirements unequivocally decrease systemic risk but at the cost of lower efficiency (measured by aggregate investment in non-liquid assets); equity requirements tend to reduce risk (hence increase stability) without reducing significantly overall investment.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 5182.

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Date of creation: 2015
Handle: RePEc:ces:ceswps:_5182
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