Abstract
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.
| Original language | English |
|---|---|
| Pages (from-to) | 98-123 |
| Number of pages | 26 |
| Journal | Network Science |
| Volume | 3 |
| Issue number | 1 |
| DOIs | |
| Publication status | Published - Mar 2015 |
| Externally published | Yes |
Keywords
- financial networks
- interbank lending
- interconnections
- key banks
- network centrality