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Hierarchical contagions in the interdependent financial network

William Barnett (), Xue Wang, Hai-Chuan Xu and Wei-Xing Zhou
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Xue Wang: Institute of Chinese Financial Studies, Southwestern University of Finance and Economics, Chengdu, China and Department of Economics, Emory University, USA
Hai-Chuan Xu: Department of Finance and Research Center for Econophysics, East China University of Science and Technology, Shanghai, China
Wei-Xing Zhou: Department of Finance and Research Center for Econophysics, East China University of Science and Technology, Shanghai, China

No 202113, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: We model hierarchical cascades of failures among banks linked through an interdependent network. The interaction among banks include not only direct cross-holding, but also indirect dependency by holding mutual assets outside the banking system. Using data extracted from the European Banking Authority, we present the interdependency network composed of 48 banks and 21 asset classes. Since interbank exposures are not public, we first reconstruct the asset/liability cross-holding network using the aggregated claims. For the robustness, we employ 3 reconstruction methods, called Anan, Hała and Maxe. Then we combine the external portfolio holdings of each bank to compute the interdependency matrix. The interdependency network is much more dense than the direct cross-holding network, showing the complex latent interaction among banks. Finally, we perform macro-prudential stress tests for the Euro- pean banking system, using the adverse scenario in EBA stress test as the initial shock. For different reconstructed networks, we illustrate the hierarchical cascades and show that the failure hierarchies are roughly the same except for a few banks, reflecting the overlapping portfolio holding accounts for the majority of defaults. Understanding the interdependency network and the hierarchy of the cascades should help to improve policy intervention and implement rescue strategy.

Keywords: financial network; interdependent network; contagions; stress test; macro-prudential. (search for similar items in EconPapers)
JEL-codes: D85 G01 G21 G32 G33 (search for similar items in EconPapers)
Date: 2021-06, Revised 2021-06
New Economics Papers: this item is included in nep-ban
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