Financial contagion in inter-bank networks with overlapping portfolios
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Financial contagion in inter-bank networks with overlapping portfolios Peilong Shen1 · Zhinan Li1 Received: 29 January 2018 / Accepted: 14 November 2019 © Springer-Verlag GmbH Germany, part of Springer Nature 2019
Abstract By considering overlapping portfolios among financial institutions, we construct a financial contagion model for inter-bank networks with two channels of contagion: counter-party risk and common asset holdings risk. Based on the model, we verify the contribution of overlapping portfolios to systemic risk contagion and further analyse how the degree of diversification and initial shock affect the probability, extent and loss degree of contagion in different network structures. The results show that as the degree of diversification increases, the probability, extent and loss degree show overall inverted U-shaped tendencies. Different from the existing research that focuses only on a single channel of risk contagion, we find that the risk contagion is significant because of the combined effect of counter-party risk and common asset holdings risk, even though there is little portfolio overlap. Additionally, we study the core–periphery network to investigate the particularity of systematically important financial institutions and the feedback effect in financial networks when banks proactively reduce the exposure of depreciating assets. Keywords Systemic risk · Contagion · Financial network · Overlapping portfolios JEL Classification G01 · G11
1 Introduction As an essential area in financial risk, systemic risk has long been a research focus around the world. The financial crisis caused by the American subprime mortgage crisis showed how contagion in financial networks amplifies individual risk to systemic risk. When financial institutions (such as banks) are highly connected in networks, an
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Zhinan Li [email protected] School of Finance, Shanxi University of Finance and Economics, No.696, Wucheng Road, Taiyuan City 030006, Shanxi Province, China
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P. Shen, Z. Li
initial shock to a single bank can spread to all banks through internal relations of nodes and lead to a systemic crisis. Therefore, the concept of financial contagion in networks has received much attention from academics in recent years. Kindleberger (1996) conducted the earliest systematic study of financial crises and the characteristics of financial contagion, and he first proposed the notion of contagion in a financial crisis. Since the 1990s, the rapid development of computer science has promoted the development of network theories, and network science has been widely applied in many fields. Applying network science to research on financial contagion provides a new perspective. Watts and Strogatz (1998) and Barabasi and Albert (1999) proposed a “small-world network” and a “scale-free network”, respectively, indicating that complex network theory was maturing. Allen and Gale (2000), pioneers in the research on financial contagion among banks in complex networks, provided a micro-economic foundation for research in this fi
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