Liu, Paddrik, Yang, Zhang, Journal of Banking and Finance, forthcoming 2018
- Working paper(pdf)
- Abstract: The potential impact of interconnected financial institutions on interbank financial systems
is a financial stability concern for central banks and regulators. In examining how financial
shocks propagate through contagion effects, we argue that endogenous individual bank choices are
necessary to properly consider how losses develop as the interbank lending network evolves.
We present an agent-based model to endogenously reconstruct interbank networks based
on 6600 banks? decision rules and behaviors reflected in quarterly balance sheets.
We compare the results of our model to the results of a traditional stationary
network framework for contagion. The model formulation reproduces dynamics similar
to those of the 2007?09 financial crisis and shows how bank losses and failures
arise from network contagion and lending market illiquidity. When calibrated to
post-crisis data from 2011 to 2014, the model shows the U.S. banking system
has reduced its likelihood of bank failures through network contagion and
illiquidity, given a similar stress scenario.