Financial stability through self-quarantine vs. system regulation in the interbank market

Nicolas Scholtes, Morgan Edwards, Jennifer Hellmann, Ellsworth Campbell, Lin Li

Research output: Contribution in Book/Catalog/Report/Conference proceedingConference contribution

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.
Original languageEnglish
Title of host publicationFinancial stability through self-quarantine vs. system regulation in the interbank market
Number of pages15
Publication statusIn preparation - 2014

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