The Link Between Incomplete Information on the Interbank Network and Counterparty Risk

Daniel Foerster () and Martin Walther ()
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Daniel Foerster: Technische Universität Berlin, Chair of Finance and Investment, Sec. H 64, Straße des 17. Juni 135, 10623 Berlin, Germany
Martin Walther: Technische Universität Berlin, Chair of Finance and Investment, Sec. H 64, Straße des 17. Juni 135, 10623 Berlin, Germany

Credit and Capital Markets, 2019, vol. 52, issue 2, 213-227

Abstract: This paper describes a model in which a network of interbank loans leads to a severe amplification of the previously unanticipated insolvency of one bank. Banks that cannot rule out an indirect hit react by selling assets and hoarding liquidity. While this potentially lowers illiquidity risks, it depresses market liquidity and prices. This leads to a negative externality by which sales to acquire liquidity simultaneously lead to lower global sale proceeds and thus to a greater number of insolvencies inducing deadweight losses. Thus, the distribution of information on the network has a direct impact on welfare by itself.

JEL-codes: G01 G11 G21 G33 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:kuk:journl:v:52:y:2019:i:2:p:213-227

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