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The effect of the interbank network structure on contagion and financial stability

Author

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  • Co-Pierre Georg

    () (School of Economics and Business Administration, Friedrich-Schiller-University Jena)

Abstract

In the wake of the financial crisis it has become clear that there is a need for macroprudential oversight in addition to the existing microprudential banking supervision. One of the lessons from the crisis is that the network structure of the banking system has to be taken into account to assess systemic risk. There exists, however, no analysis on the influence of the network topology on contagion in financial networks. This paper therefore compares contagion in Barabási-Albert (scale-free) with Watts-Strogatz (small-world) and random networks. A network model of banks, a firm- and household-sector as well as a central bank is used. Banks optimize a portfolio of risky investments and risk-free excess reserves according to their risk and liquidity preferences. They form a network via interbank loans and face a stochastic supply of household deposits. Contagion effects from the default of a large bank are studied in different network topologies. The results indicate that contagion is more severe in random and scale-free networks than in small-world networks. This situation changes when the central bank is not active in which case small-world networks are less stable than scale-free and random networks. It is also shown that interbank liquidity above a certain threshold leads to endogenous instability, regardless of the network topology. The results further indicate that network heterogeneity does not contribute to financial instability.

Suggested Citation

  • 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.
  • Handle: RePEc:hlj:hljwrp:12-2010
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    File URL: http://pubdb.wiwi.uni-jena.de/pdf/wp_hlj12-2010.pdf
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    References listed on IDEAS

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    1. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads : The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
    2. Galbiati, Marco & Soramäki, Kimmo, 2011. "An agent-based model of payment systems," Journal of Economic Dynamics and Control, Elsevier, vol. 35(6), pages 859-875, June.
    3. Castrén, Olli & Kavonius, Ilja Kristian, 2009. "Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area," Working Paper Series 1124, European Central Bank.
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    Citations

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    Cited by:

    1. Francisco Blasques & Falk Bräuning & Iman van Lelyveld, 2015. "A dynamic network model of the unsecured interbank lending market," BIS Working Papers 491, Bank for International Settlements.
    2. Fischer, Thomas & Riedler, Jesper, 2014. "Prices, debt and market structure in an agent-based model of the financial market," Journal of Economic Dynamics and Control, Elsevier, vol. 48(C), pages 95-120.
    3. Fabio Caccioli & Thomas A. Catanach & J. Doyne Farmer, 2011. "Heterogeneity, correlations and financial contagion," Papers 1109.1213, arXiv.org.
    4. De Kamps, Marc & Ladley, Daniel & Simaitis, Aistis, 2014. "Heterogeneous beliefs in over-the-counter markets," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 50-68.
    5. Leonidas Sandoval Junior, 2014. "Dynamics in two networks based on stocks of the US stock market," Papers 1408.1728, arXiv.org, revised Aug 2014.
    6. Sandoval, Leonidas Junior, 2013. "To lag or not to lag? How to compare indices of stock markets that operate at different times," Insper Working Papers wpe_319, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    7. Luiz Awazu Pereira da Silva & Adriana Soares Sales & Wagner Piazza Gaglianone, 2013. "Financial stability in Brazil," Chapters,in: Stability of the Financial System, chapter 4 Edward Elgar Publishing.
    8. Fabio Caccioli & Munik Shrestha & Cristopher Moore & J. Doyne Farmer, 2012. "Stability analysis of financial contagion due to overlapping portfolios," Papers 1210.5987, arXiv.org.

    More about this item

    Keywords

    systemic risk; contagion; interbank markets; network models;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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