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

45 Pages Posted: 22 Dec 2016 Last revised: 26 Jul 2017

See all articles by Anqi Liu

Anqi Liu

Cardiff University - School of Mathematics

Mark E. Paddrik

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

Steve Y. Yang

Stevens Institute of Technology

Xingjia Zhang

Stevens Institute of Technology

Date Written: December 20, 2016

Abstract

The potential impact of interconnected financial institutions on interbank financial systems is a financial stability concern for central banks and regulators. In examining how financial shocks propagate through contagion effects, we argue that endogenous individual bank choices are necessary to properly consider how losses develop as the interbank lending network evolves. 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. We compare the results of our model to the results of a traditional stationary network framework for contagion. 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 U.S. 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

JEL Classification: D85, G17, G21, L14

Suggested Citation

Liu, Anqi and Paddrik, Mark Endel and Yang, Steve Y. and Zhang, Xingjia, Interbank Contagion: An Agent-Based Model Approach to Endogenously Formed Networks (December 20, 2016). OFR WP 16-14, Available at SSRN: https://ssrn.com/abstract=2888562 or http://dx.doi.org/10.2139/ssrn.2888562

Anqi Liu

Cardiff University - School of Mathematics ( email )

Senghennydd Road
Cardiff, CF24 4AG
United Kingdom

Mark Endel Paddrik (Contact Author)

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

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

Steve Y. Yang

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Xingjia Zhang

Stevens Institute of Technology

Hoboken, NJ 07030
United States

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