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Endogenous Banks' Networks, Cascades and Systemic Risk

SAFE Working Paper No. 12

76 Pages Posted: 20 Mar 2013 Last revised: 4 Jul 2014

Marcel Bluhm

Wang Yanan Institute for Studies in Economics; Center for Financial Studies

Ester Faia

Goethe University Frankfurt; Kiel Institute for the World Economy; French National Center for Scientific Research (CNRS) - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

Jan Pieter Krahnen

Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Center for Financial Studies (CFS); Centre for Economic Policy Research (CEPR)

Date Written: June 2014

Abstract

We develop a network model whose links are governed by banks' optimizing 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.

Keywords: network formation, tâtonnement, contagion

JEL Classification: C63, D85, G01,G28

Suggested Citation

Bluhm, Marcel and Faia, Ester and Krahnen, Jan Pieter, Endogenous Banks' Networks, Cascades and Systemic Risk (June 2014). SAFE Working Paper No. 12. Available at SSRN: https://ssrn.com/abstract=2235520 or http://dx.doi.org/10.2139/ssrn.2235520

Marcel Bluhm

Wang Yanan Institute for Studies in Economics ( email )

A 307, Economics Building
Xiamen, Fujian 361005
China

Center for Financial Studies ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Ester Faia (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Kiel Institute for the World Economy

P.O. Box 4309
Kiel, D-24100
Germany

French National Center for Scientific Research (CNRS) - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

Ecole Normale Superieure
48 boulevard Jourdan
75014 Paris
France

Jan Pieter Krahnen

Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 33699 (Phone)
+49 69 798 33901 (Fax)

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 30080 (Phone)
+49 69 798 30077 (Fax)

Center for Financial Studies (CFS) ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 30050 (Phone)
+49 69 798 30077 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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