Abstract
The paper develops a dynamic network model of the interbank market focussing on
containment strategies for an initial shock engendering a cascading string of failures.
To do this, we begin with a system regulator possessing a fixed bank recapitalization
budget and information set vis-à-vis the network. We also consider self-quarantining
behaviour whereby individual banks respond to spreading failures by unilaterally cut-
ting ties to neighbors. Our results show that imperfect information affects the ability
of the regulator to contain larger shocks in the absence of self-quarantining behaviour. By contrast, self-quarantine and imperfect information appeared to complement one another, resulting in near-perfect system preservation.
containment strategies for an initial shock engendering a cascading string of failures.
To do this, we begin with a system regulator possessing a fixed bank recapitalization
budget and information set vis-à-vis the network. We also consider self-quarantining
behaviour whereby individual banks respond to spreading failures by unilaterally cut-
ting ties to neighbors. Our results show that imperfect information affects the ability
of the regulator to contain larger shocks in the absence of self-quarantining behaviour. By contrast, self-quarantine and imperfect information appeared to complement one another, resulting in near-perfect system preservation.
| Original language | English |
|---|---|
| Title of host publication | Financial stability through self-quarantine vs. system regulation in the interbank market |
| Number of pages | 15 |
| Publication status | In preparation - 2014 |