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Endogenous banks' networks, cascades and systemic risk

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  • Bluhm, Marcel
  • Faia, Ester
  • Krahnen, Jan Pieter

Abstract

We develop a network model whose links are governed by banks' optmizing decisions and by an endogenous tâtonnement market adjustment. Banks in our model can default and engage in re-sales: risk is transmitted through direct and cascading counterparty defaults as well as through indirect pecuniary externalities triggered by re-sales. We use the model to assess the evolution of the network configuration under various prudential policy regimes, to measure banks' contribution to systemic risk (through Shapley values) in response to shocks, and to analyze the effects of systemic risk charges. We complement the analysis by introducing the possibility of central bank liquidity provision.

Suggested Citation

  • Bluhm, Marcel & Faia, Ester & Krahnen, Jan Pieter, 2014. "Endogenous banks' networks, cascades and systemic risk," SAFE Working Paper Series 12, Leibniz Institute for Financial Research SAFE, revised 2014.
    • Handle: RePEc:zbw:safewp:12
    DOI: 10.2139/ssrn.2235520
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    References listed on IDEAS

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    6. Antje Brunner & Jan Pieter Krahnen, 2008. "Multiple Lenders and Corporate Distress: Evidence on Debt Restructuring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(2), pages 415-442.
    7. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-638, August.
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    9. Ricardo J. Caballero & Alp Simsek, 2013. "Fire Sales in a Model of Complexity," Journal of Finance, American Finance Association, vol. 68(6), pages 2549-2587, December.
    10. Grunert, Jens & Weber, Martin, 2009. "Recovery rates of commercial lending: Empirical evidence for German companies," Journal of Banking & Finance, Elsevier, vol. 33(3), pages 505-513, March.
    11. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
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    Citations

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    Cited by:

    1. Georg, Co-Pierre, 2014. "Contagious herding and endogenous network formation in financial networks," Working Paper Series 1700, European Central Bank.
    2. Sheri M Markose, 2013. "Systemic risk analytics: A data-driven multi-agent financial network (MAFN) approach," Journal of Banking Regulation, Palgrave Macmillan, vol. 14(3-4), pages 285-305, July.
    3. Maryam Farboodi, 2014. "Intermediation and Voluntary Exposure to Counterparty Risk," 2014 Meeting Papers 365, Society for Economic Dynamics.
    4. Hałaj, Grzegorz, 2018. "System-wide implications of funding risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 503(C), pages 1151-1181.
    5. Montagna, Mattia & Lux, Thomas, 2014. "Contagion Risk in the Interbank Market: A Probabilistic Approach to Cope with Incomplete Structural Information," FinMaP-Working Papers 8, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.
    6. Bluhm, Marcel & Krahnen, Jan Pieter, 2014. "Systemic risk in an interconnected banking system with endogenous asset markets," Journal of Financial Stability, Elsevier, vol. 13(C), pages 75-94.
    7. Stepanchuk Serhiy & Ádám Reiff, 2012. "11th Annual Macroeconomic Policy Research Workshop at MNB: Microeconomic Behavior and its Macroeconomic Implications During the Financial Crisis," MNB Bulletin (discontinued), Magyar Nemzeti Bank (Central Bank of Hungary), vol. 7(3), pages 67-72, October.
    8. Jose Fique, 2015. "A Microfounded Design of Interconnectedness-Based Macroprudential Regulation," CAEPR Working Papers 2015-008, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    9. Hong Fan & Chirongo Moses Keregero & Qianqian Gao, 2018. "The Application of Macroprudential Capital Requirements in Managing Systemic Risk," Complexity, Hindawi, vol. 2018, pages 1-15, January.
    10. Montagna, Mattia & Lux, Thomas, 2014. "Contagion risk in the interbank market: A probabilistic approach to cope with incomplete structural information," Kiel Working Papers 1937, Kiel Institute for the World Economy (IfW Kiel).

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    More about this item

    Keywords

    Network formation; tâtonnement; contagion;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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