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Financial Contagion in the Laboratory: Does Network Structure Matter?

Author

Listed:
  • John Duffy

    () (Department of Economics, University of California-Irvine)

  • Aikaterini Karadimitropoulou

    () (School of Economics, University of East Anglia)

  • Melanie Parravano

    () (Business School, Newcastle University)

Abstract

We design and report on laboratory experiments exploring the role of interbank network structure for the likelihood of a financial contagion. The laboratory provides us with the control necessary to precisely explore the role of different network configurations for the fragility of the financial system. Specifically, we study the likelihood of financial contagion in complete and incomplete networks of banks who are linked in terms of interbank deposits as in the model of Allen and Gale (2000). Subjects play the role of depositors who must decide whether or not to withdraw their funds from their bank. We find that financial contagions are possible under both network structures. While such contagions always occur under an incomplete interbank network structure, they are significantly less likely to occur under a complete interbank network structure where interbank linkages can effectively provide insurance against shocks to the system, and localize damage from the financial shock.

Suggested Citation

  • John Duffy & Aikaterini Karadimitropoulou & Melanie Parravano, 2016. "Financial Contagion in the Laboratory: Does Network Structure Matter?," Working Papers 151608, University of California-Irvine, Department of Economics.
  • Handle: RePEc:irv:wpaper:151608
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    File URL: https://www.economics.uci.edu/research/wp/1516/15-16-08.pdf
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    References listed on IDEAS

    as
    1. Hubert Janos Kiss & Ismael Rodriguez‐Lara & Alfonso Rosa‐García, 2012. "On the Effects of Deposit Insurance and Observability on Bank Runs: An Experimental Study," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(8), pages 1651-1665, December.
    2. Garratt, Rod & Keister, Todd, 2009. "Bank runs as coordination failures: An experimental study," Journal of Economic Behavior & Organization, Elsevier, vol. 71(2), pages 300-317, August.
    3. Kiss, Hubert Janos & Rodriguez-Lara, Ismael & Rosa-García, Alfonso, 2014. "Do social networks prevent or promote bank runs?," Journal of Economic Behavior & Organization, Elsevier, vol. 101(C), pages 87-99.
    4. Chakravarty, Surajeet & Fonseca, Miguel A. & Kaplan, Todd R., 2014. "An experiment on the causes of bank run contagions," European Economic Review, Elsevier, vol. 72(C), pages 39-51.
    5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    6. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153.
    7. Martin Brown & Stefan Trautmann & Razvan Vlahu, 2012. "Contagious Bank Runs: Experimental Evidence," DNB Working Papers 363, Netherlands Central Bank, Research Department.
    8. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
    9. Bock, Olaf & Baetge, Ingmar & Nicklisch, Andreas, 2014. "hroot: Hamburg Registration and Organization Online Tool," European Economic Review, Elsevier, vol. 71(C), pages 117-120.
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    Cited by:

    1. Hubert Janos Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2018. "Who runs first to the bank?," IEHAS Discussion Papers 1826, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.

    More about this item

    Keywords

    Contagion; Networks; Experiments; Bank runs; Interbank seposits; Financial fragility;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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