Contagion in a Network of Heterogeneous Banks

56 Pages Posted: 20 Sep 2017 Last revised: 18 Dec 2019

See all articles by Ramazan Gencay

Ramazan Gencay

Simon Fraser University

Hao Pang

Duke University, Fuqua School of Business, Students

Michael Tseng

University of Central Florida

Yi Xue

University of International Business and Economics (UIBE)

Date Written: August 1, 2017

Abstract

We consider a financial network where banks are heterogeneous in scales and each bank has only local knowledge regarding the network. Each bank must make counterparty and portfolio decisions while facing uncertainty regarding the network structure. Such uncertainty plays an important role in banks' risk management practices in minimizing the effect of exogenous liquidity shocks and hedging against possible fire-sale in asset markets. This results in an endogenous core-periphery structure which is optimal in mitigating financial contagion yet concentrates systemic risk at the core of big banks.

Keywords: Financial networks, Contagion, Heterogeneous banks, Core-Periphery structure, Network externality

JEL Classification: G01, G22, G28

Suggested Citation

Gencay, Ramazan and Pang, Hao and Tseng, Michael and Xue, Yi, Contagion in a Network of Heterogeneous Banks (August 1, 2017). Available at SSRN: https://ssrn.com/abstract=3039399 or http://dx.doi.org/10.2139/ssrn.3039399

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Hao Pang

Duke University, Fuqua School of Business, Students ( email )

Durham, NC
United States

Michael Tseng (Contact Author)

University of Central Florida ( email )

4000 Central Florida Blvd
Orlando, FL 32816-1400
United States

Yi Xue

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

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