Abstract
We analyze cascades of defaults in an interbank loan market. The novel feature of this study is that the network structure and the size distribution of banks are derived from empirical data. We find that the ability of a defaulted institution to start a cascade depends on an interplay of shock size and connectivity. Further results indicate that the interbank loan network is structurally less stable after the financial crisis than it was before. To evaluate the influence of the network structure on market stability, we compare simulated cascades from the empirical network with results from different network models. The results show that the empirical network has non-random features, which cannot be captured by randomized networks. The analysis also reveals that simulations that assume homogeneity for banks and loan size tend to overestimate the fragility of the interbank market.
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Notes
We choose this specification to ensure that bank’s capital is always consistent with interbank market exposures and does not fluctuate wildly. We obtained qualitatively similar simulation results by estimating \(\textit{TA}\) only from the current day’s activity, and for estimating \(\textit{TA}\) only from interbank lending. However, the results were more noisy, and, in the latter case, lead to an indeterminacy for banks that are only borrowing.
The difference in the cascade size between 2006 and 2011 is not caused by a sudden change. We simulated the cascade size for all remaining years, and found that the average cascade size gradually increases, while the average degree of the network steadily decreases throughout the years.
The results are very similar for the empirical network from 2006.
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Acknowledgments
The authors thank Petter Holme, Martin Rosvall, and Thomas Lux for helpful discussions. FK thanks the Swedish Research Council. MR thanks the Leibniz Association for partial funding of this project.
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Karimi, F., Raddant, M. Cascades in Real Interbank Markets. Comput Econ 47, 49–66 (2016). https://doi.org/10.1007/s10614-014-9478-z
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DOI: https://doi.org/10.1007/s10614-014-9478-z