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Systemic risk in a network model of interbank markets with central bank activity

  • Co-Pierre Georg

    ()

    (Graduate School "Global Financial Markets - Stability and Change", Friedrich-Schiller-Universität Jena)

  • Jenny Poschmann

    ()

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

The breakdown of the interbank money markets in the face of the recent financial crisis has forced central banks and governments to take extraordinary measures to sustain financial stability. In this paper we investigate which influence central bank activity has on interbank markets. In our model, banks optimize a portfolio of risky investments and riskless excess reserves according to their risk and liquidity preferences. They are linked via interbank loans and face a stochastic supply of household deposits. We then introduce a central bank into the model and show that central bank activity enhances financial stability. We model the default of a large bank and analyse the resulting contagion effects. This is compared to a common shock that hits banks who have invested in similiar assets. Our results indicate that common shocks are not subordinate to contagion effects, but are instead the greater threat to systemic stability.

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Paper provided by Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics in its series Jena Economic Research Papers with number 2010-033.

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Date of creation: 01 Jun 2010
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Handle: RePEc:jrp:jrpwrp:2010-033
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  16. Sheri Markose & Simone Giansante & Mateusz Gatkowski & Ali Rais Shaghaghi, 2010. "Too Interconnected To Fail: Financial Contagion and Systemic Risk in Network Model of CDS and Other Credit Enhancement Obligations of US Banks," Economics Discussion Papers 683, University of Essex, Department of Economics.
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