The Formation of a Core-Periphery Structure in Heterogeneous Financial Networks
65 Pages Posted: 8 Nov 2016
Date Written: November 4, 2016
Recent empirical evidence suggests that financial networks exhibit a core-periphery network structure. This paper aims at giving an explanation for the emergence of such a structure using network formation theory. We propose a simple model of the overnight interbank lending market, in which banks compete for intermediation benefits. Focusing on the role of bank heterogeneity, we find that a core-periphery network cannot be unilaterally stable when banks are homogeneous. A core-periphery network structure can form endogenously, however, if we allow for heterogeneity among banks in size. Moreover, size heterogeneity may arise endogenously if payoffs feed back into bank size.
Keywords: financial networks, core-periphery structure, network formation models, over-the-counter markets, interbank market
JEL Classification: D85, G21, L14
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