Filling in the blanks: network structure and interbank contagion

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. iii Terms of use: Documents in AbstractThe network pattern of financial linkages is important in many areas of banking and finance. Yet bilateral linkages are often unobserved, and maximum entropy serves as the leading method for estimating counterparty exposures. This paper proposes an efficient alternative that combines information-theoretic arguments with economic incentives to produce more realistic interbank networks that preserve important characteristics of the original interbank market. The method loads the most probable links with the largest exposures consistent with the total lending and borrowing of each bank, yielding networks with minimum density. When used in a stress-testing context, the minimumdensity solution overestimates contagion, whereas maximum entropy underestimates it. Using the two benchmarks side by side defines a useful range that bounds the cost of systemic stress present in the true interbank network when counterparty exposures are unknown. JEL classification: G21, L14, D85, C63 Bank classification: Econometric and statistical methods; Financial institutions; Financial stability RésuméLe réseau de liens financiers est important dans de nombreux segments des secteurs bancaire et financier. Pourtant, dans bien des cas, les liens bilatéraux ne sont pas observés et la méthode de l'entropie maximale est la plus couramment utilisée pour estimer les expositions au risque de contrepartie. Dans leur étude, les auteurs proposent une solution de rechange efficace qui combine des arguments relevant de la théorie de l'information et des arguments économiques pour créer des réseaux interbancaires hypothétiques plus réalistes qui préservent les principales caractéristiques du marché interbancaire original. La méthode consiste à tenir compte des liens les plus probables en fonction de la taille des expositions entre les banques, selon le total des prêts et des emprunts de chacune, afin de générer des réseaux ayant une densité minimale. Dans le contexte des tests de résistance, la méthode axée sur la densité minimale surestime la contagion, alors que celle de l'entropie maximale la sous-estime. En ayant recours aux deux modèles en parallèle, on peut ainsi définir une fourchette utile qui délimite le coût attribuable aux tensions systémiques présentes dans le réseau interbancaire réel lorsque les expositions au risque de contrepartie sont inconnues.

An Agent-Based Approach to Interbank Market Lending Decisions and Risk Implications

“…The key reason for applying a learning approach is to overcome the difficulties in reproducing bilateral lending-borrowing relationships through balance sheet data. Existing analytical solutions to the bilateral exposure problem largely rely on some sort of optimization scheme that produces unrealistic results [34,35]. Knowing that these solutions cannot be improved to produce a more realistic model, we allow the agents to reorganize their lending-borrowing decisions to form bilateral links naturally through the reinforcement learning.…”

Contagion in Financial Systems: A Bayesian Network Approach

“…All parameters and quantities introduced above are assumed to be known or have been estimated before. We refer to Anand et al (2015), Gandy and Veraart (2016) and Upper (2011) for various methods to estimate interfirm exposures. Based on the previously described set-up, the balance sheet of firm i at time t = 0 has the form depicted on the left-hand side of Figure 1.…”

Is full banking integration desirable?

“…Therefore, our proposal to measure different aspects of banking integration, although not free from limitations, has several advantages, briefly summarized as follows: (i) the measure of connectedness is related to the increasing number of initiatives that have attempted to model the global banking network and different issues related to the connectedness of banking systems (Anand et al, 2015), inspired by the seminal work of Allen and Gale (2000); (ii) our measure of openness also takes into account that de jure integration might not necessarily imply de facto integration, as suggested by (Bekaert et al, 2013;Kalemli-Ozcan et al, 2013); (iii) it is based on quantities and, therefore, could be considered as a quantity counterpart to the Law of One Price (LOOP); (iv) it considers the existence of both direct and indirect links, which in the case of financial and banking integration are quite relevant due to the contagious capacity of the international banking network (Bicu and Candelon, 2013); (v) the measure of openness 2 The degree of banking connectedness has two possible extensions: considering also indirect links between economies and controlling for distance. The former takes into account that flows from country i to country j may cross third countries, and those indirect flows also contribute to integration.…”