Stress Testing the Unknown - The Impact of Network Reconstruction on Systemic Risk Estimates

27 Pages Posted: 8 Mar 2019 Last revised: 25 Jan 2020

See all articles by Fabian Woebbeking

Fabian Woebbeking

Goethe University Frankfurt - Department of Finance

Date Written: January 23, 2020

Abstract

Banks connect through a complex network of interbank credit exposures that determine contagion and hence the systemic stability of the network. Yet, the bilateral linkages of these institutions and thus the true structure of the network are typically unobservable, with leading reconstruction methods, such as maximum entropy or minimum density, potentially underestimating the true contagion risk of the network. Based on publicly available data from large European institutions, this paper analyses different network reconstruction techniques and the contagion risk impact of different network structures in a stress testing context. My findings suggest that uncertainty about the true interbank network leads to substantially varying risk assessments, where a Bayesian reconstruction approach can be used to identify contagion risk boundaries. In addition, network structure metrics that explain the variation in risk assessments are identified.

Keywords: systemic risk, network reconstruction, bank network structure, contagion

JEL Classification: D85, G21, L14

Suggested Citation

Woebbeking, Fabian, Stress Testing the Unknown - The Impact of Network Reconstruction on Systemic Risk Estimates (January 23, 2020). Available at SSRN: https://ssrn.com/abstract=3336548 or http://dx.doi.org/10.2139/ssrn.3336548

Fabian Woebbeking (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany
+49 (69) 798 33731 (Phone)

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