Interbank Contagion: An Agent-Based Model (ABM) Approach to Endogenously Formed Networks

40 Pages Posted: 10 May 2016 Last revised: 10 Jan 2017

See all articles by Steve Y. Yang

Steve Y. Yang

Stevens Institute of Technology

Anqi Liu

Cardiff University - School of Mathematics

Xingjia Zhang

Stevens Institute of Technology

Mark E. Paddrik

Government of the United States of America - Office of Financial Research

Date Written: November 10, 2016

Abstract

The potential impact of interconnected financial institutions on interbank financial systems is a financial stability concern for central banks and regulators. A number of algorithms/methods have been developed to extrapolate latent interbank risk exposures. However, most use highly stylized network models and reconstruction methods with global optimality lending allocation approaches such as maximizing entropy or minimizing costs. This paper argues that U.S. bank lending and borrowing decisions are largely suboptimal and performance-driven. We present an agent-based model to endogenously reconstruct interbank networks based on 6,600 banks' decision rules and behaviors reflected in quarterly balance sheets. 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 2011-14, the model shows the banking system has reduced its likelihood of bank failures through network contagion and illiquidity, given a similar stress scenario.

Keywords: Interbank lending market, Agent-based simulation, Contagion risk, Network topology, Financial crisis

JEL Classification: C63, G01, G17, G21

Suggested Citation

Yang, Steve Y. and Liu, Anqi and Zhang, Xingjia and Paddrik, Mark Endel, Interbank Contagion: An Agent-Based Model (ABM) Approach to Endogenously Formed Networks (November 10, 2016). Available at SSRN: https://ssrn.com/abstract=2777507 or http://dx.doi.org/10.2139/ssrn.2777507

Steve Y. Yang (Contact Author)

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Anqi Liu

Cardiff University - School of Mathematics ( email )

Senghennydd Road
Cardiff, CF24 4AG
United Kingdom

Xingjia Zhang

Stevens Institute of Technology

Hoboken, NJ 07030
United States

Mark Endel Paddrik

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

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