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Static and dynamic networks in interbank markets

Published online by Cambridge University Press:  12 February 2015

ETHAN COHEN-COLE ,
ELEONORA PATACCHINI  and
YVES ZENOU
ETHAN COHEN-COLE
Affiliation:
Econ One Research, 2040 Bancroft Ave #200, Berkeley, CA 94708, USA (e-mail: ecohencole@econone.com)
ELEONORA PATACCHINI
Affiliation:
Department of Economics, Cornell University, Ithaca, NY 14853, USA (e-mail: ep454@cornell.edu)
YVES ZENOU
Affiliation:
Department of Economics, Stockholm University and IFN, 106 91 Stockholm, Sweden (e-mail: yves.zenou@ne.su.se)
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Abstract

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This paper proposes a model of network interactions in the interbank market. Our innovation is to model systemic risk in the interbank network as the propagation of incentives or strategic behavior rather than the propagation of losses after default. Transmission in our model is not based on default. Instead, we explain bank profitability based on competition incentives and the outcome of a strategic game. As competitors' lending decisions change, banks adjust their own decisions as a result: generating a “transmission” of shocks through the system. We provide a unique equilibrium characterization of a static model, and embed this model into a full dynamic model of network formation. We also determine the key bank, which is the bank that is crucial for the stability of the financial network.

Keywords

financial networksinterbank lendinginterconnectionsnetwork centralitykey banksG10C21D85
Type
Research Article
Information
Network Science , Volume 3 , Issue 1: Networks in Space and in Time: Methods and Applications , March 2015 , pp. 98 - 123
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/3.0/), which permits unrestricted re-use, distribution, and reproduction in any medium, provided the original work is properly cited.
Copyright
Copyright © Cambridge University Press 2015

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