Network Risk and Key Players: A Structural Analysis of Interbank Liquidity

63 Pages Posted: 14 Dec 2016 Last revised: 20 Sep 2018

Edward Denbee

Bank of England

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Economics; Centre for Economic Policy Research (CEPR)

Ye Li

Ohio State University

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: September 11, 2018

Abstract

We estimate the liquidity multiplier and individual banks' contribution to systemic liquidity risk in an interbank network using a structural model. Banks borrow liquidity from neighbours and update their valuation based on neighbours' actions. When the former (latter) motive dominates, the equilibrium exhibits strategic substitution (complementarity) of liquidity holdings, and a reduced (increased) liquidity multiplier dampening (amplifying) shocks. Empirically, we find substantial and procyclical network-generated risks driven mostly by changes of equilibrium type rather than network topology. We identify the banks that generate most systemic risk and solve the planner's problem, providing guidance to macro-prudential policies.

Keywords: Liquidity, Interbank Market, Network, Systemic Risk, Strategic Complementarity, Amplification Mechanism

Suggested Citation

Denbee, Edward and Julliard, Christian and Li, Ye and Yuan, Kathy Zhichao, Network Risk and Key Players: A Structural Analysis of Interbank Liquidity (September 11, 2018). Fisher College of Business Working Paper No. 2018-03-011; Charles A. Dice Center Working Paper No. 2018-11; Columbia Business School Research Paper No. 17-6. Available at SSRN: https://ssrn.com/abstract=2884461 or http://dx.doi.org/10.2139/ssrn.2884461

Edward Denbee

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Ye Li (Contact Author)

Ohio State University ( email )

Fisher Hall 836, 2100 Neil Ave
Columbus, OH 43210
United States

HOME PAGE: http://yeli-macrofinance.com

Kathy Zhichao Yuan

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Old Building
Houghton Street
London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
+44 (0)20 7849 4647 (Fax)

HOME PAGE: http://fmg.lse.ac.uk/~kathy

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