scispace - formally typeset
Search or ask a question
Journal ArticleDOI

Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns

01 May 2011-Journal of Banking and Finance (North-Holland)-Vol. 35, Iss: 5, pp 1114-1127
TL;DR: In this article, the authors analyzed how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures, based on the availability of information on bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims.
Abstract: Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may represent a channel for contagion as a bank default may spread to other banks through interbank linkages. This paper analyses how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Based on the availability of information on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banks’ capitalisation, the maximum entropy approach overrates the scope for contagion.

Content maybe subject to copyright    Report

Citations
More filters
Journal ArticleDOI
TL;DR: In this paper, the state-of-the-art algorithms for vital node identification in real networks are reviewed and compared, and extensive empirical analyses are provided to compare well-known methods on disparate real networks.

919 citations

Journal ArticleDOI
TL;DR: In this paper, the authors develop an analytical model of contagion in financial networks with arbitrary structure and explore how the probability and potential impact of the contagion is influenced by aggregate and non-aggregated information.
Abstract: This paper develops an analytical model of contagion in financial networks with arbitrary structure. We explore how the probability and potential impact of contagion is influenced by aggregate and ...

763 citations

Journal ArticleDOI
TL;DR: DebtRank, a novel measure of systemic impact inspired by feedback-centrality, is introduced, finding that a group of 22 institutions, which received most of the funds, form a strongly connected graph where each of the nodes becomes systemically important at the peak of the crisis.
Abstract: Systemic risk, here meant as the risk of default of a large portion of the financial system, depends on the network of financial exposures among institutions. However, there is no widely accepted methodology to determine the systemically important nodes in a network. To fill this gap, we introduce, DebtRank, a novel measure of systemic impact inspired by feedback-centrality. As an application, we analyse a new and unique dataset on the USD 1.2 trillion FED emergency loans program to global financial institutions during 2008–2010. We find that a group of 22 institutions, which received most of the funds, form a strongly connected graph where each of the nodes becomes systemically important at the peak of the crisis. Moreover, a systemic default could have been triggered even by small dispersed shocks. The results suggest that the debate on too-big-to-fail institutions should include the even more serious issue of too-central-to-fail.

757 citations

Journal ArticleDOI
TL;DR: This review clarifies the concepts and metrics, classify the problems and methods, as well as review the important progresses and describe the state of the art, and provides extensive empirical analyses to compare well-known methods on disparate real networks and highlight the future directions.
Abstract: Real networks exhibit heterogeneous nature with nodes playing far different roles in structure and function. To identify vital nodes is thus very significant, allowing us to control the outbreak of epidemics, to conduct advertisements for e-commercial products, to predict popular scientific publications, and so on. The vital nodes identification attracts increasing attentions from both computer science and physical societies, with algorithms ranging from simply counting the immediate neighbors to complicated machine learning and message passing approaches. In this review, we clarify the concepts and metrics, classify the problems and methods, as well as review the important progresses and describe the state of the art. Furthermore, we provide extensive empirical analyses to compare well-known methods on disparate real networks, and highlight the future directions. In despite of the emphasis on physics-rooted approaches, the unification of the language and comparison with cross-domain methods would trigger interdisciplinary solutions in the near future.

542 citations

Journal ArticleDOI
TL;DR: In this article, the authors show that a financial network can be most resilient for intermediate levels of risk diversification, and not when this is maximal, as generally thought so far, and this finding holds in the presence of the financial accelerator, i.e., when negative variations in the financial robustness of an agent tend to persist in time because they have adverse effects on the agent's subsequent performance through the reaction of the agents counterparties.

500 citations

References
More filters
Journal ArticleDOI
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
Abstract: This paper shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.

9,099 citations

Journal ArticleDOI
TL;DR: In this paper, the authors investigated whether the much-heralded fall in the cost of abating SO2, compared to original estimates, can be attributed to allowance trading and demonstrated that, for plants that use low-sulfur coal to reduce SO2 emissions, technical change and the fall in prices of low sulfur coal have lowered marginal abatement cost curves by over 50 percent since 1985.
Abstract: Title IV of the 1990 Clean Air Act Amendments (CAAA) established a market for transferable sulfur dioxide (SO2) emission allowances among electric utilities. This market offers firms facing high marginal abatement costs the opportunity to purchase the right to emit SO2 from firms with lower costs, and this is expected to yield cost savings compared to a command‐and‐control approach to environmental regulation. This paper uses econometrically estimated marginal abatement cost functions for power plants affected by Title IV of the CAAA to evaluate the performance of the SO2 allowance market. Specifically, we investigate whether the much‐heralded fall in the cost of abating SO2, compared to original estimates, can be attributed to allowance trading. We demonstrate that, for plants that use low‐sulfur coal to reduce SO2 emissions, technical change and the fall in prices of low‐sulfur coal have lowered marginal abatement cost curves by over 50 percent since 1985. The flexibility to take advantage of these chan...

1,112 citations

Journal ArticleDOI
TL;DR: In this paper, the authors model systemic risk in an interbank market and investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of a bank generates a chain reaction on the rest of the system.
Abstract: We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments systemic repercussions and we examine the justification of the Too-big-to-fail-policy.

1,073 citations

Journal ArticleDOI
TL;DR: In this article, the authors investigated whether the flexability afforded by decentralized bank interactions can be preserved while protecting the central banks from the necessity of conducting undesired rescue operations and derived the optimal prudential rules, and in particular looked at the impact of interbank monitoring on the solvency and liquidity ratios of borrowing and lending banks.
Abstract: Systemic risk refers to the propagation of a bank's economic distress to other economic agents linked to that bank through financial transactions. Banking authorities often prevent systemic risk through an implicit insurance of interbank claims, or by reducing interbank transactions and centralizing banks' liquidity management. This paper investigates whether the flexability afforded by decentralized bank interactions can be preserved while protecting the central banks from the necessity of conducting undesired rescue operations. It develops a model in which decentralized interbank leading is motivated by peer monitoring. In this context, the paper derives the optimal prudential rules, and, in particular, looks at the impact of interbank monitoring on the solvency and liquidity ratios of borrowing and lending banks. Last, it provides conditions which a Too Big To Fail policy is or is not justified and studies the possibility of propagation of a bank's liquidity shock throughout the financial system. Copyright 1996 by Ohio State University Press.

856 citations

Journal ArticleDOI
TL;DR: In this paper, the authors contrast panics and information-based bank runs in an effort to provide a robust and empirically plausible model of how bank runs are triggered by two-sided asymmetric information: the bank cannot observe the true liquidity needs of the depositors while depositors are asymmetrically informed about bank asset quality.
Abstract: In this paper we contrast panics and information-based bank runs in an effort to provide a robust and empirically plausible model of how bank runs are triggered. The model of information-based runs is characterized by two-sided asymmetric information: the bank cannot observe the true liquidity needs of the depositors while depositors are asymmetrically informed about bank asset quality. We also examine the relative degrees of risk sharing provided by bank deposit contracts and traded equity contracts. We show that the choice of deposit or equity depends on the attributes of and information about the underlying investment returns.

695 citations

Trending Questions (1)
Italian bank interbank market are borrowers?

The paper analyzes the Italian interbank market and includes information on actual bilateral exposures for all Italian banks.