The Transmission of Shocks in Endogenous Financial Networks: A Structural Approach

Jonas Heipertz, Amine Ouazad () and Romain Ranciere

No 26049, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The paper uses bank- and instrument-level data on asset holdings and liabilities to identify and estimate a general equilibrium model of trade in financial instruments. Bilateral ties are formed as each bank selects the size and the diversification of its assets and liabilities. Shocks propagate due to the response, rather than the size, of bilateral ties to such shocks. This general equilibrium propagation of shocks reveals a financial network where the strength of a tie is determined by the sensitivity of an instrument’s return to other instruments’ returns. General equilibrium analysis predicts the propagation of real, financial and policy shocks. The network’s shape adjusts endogenously in response to shocks, to either amplify or mitigate partial equilibrium shocks. The network exhibits key theoretical properties: (i) more connected networks lead to less amplification of partial equilibrium shocks, (ii) the influence of a bank’s equity is independent of the size of its holdings; (ii) more risk-averse banks are more diversified, lowering their own volatility but increasing their influence on other banks. The general equilibrium based network model is structurally estimated on disaggregated data for the universe of French banks. We used the estimated network to assess the effects of ECB quantitative easing policy on asset prices, balance-sheets, individual bank distress risk, and networks systemicness.

JEL-codes: E44 E52 G11 G12 G21 (search for similar items in EconPapers)
Date: 2019-07
New Economics Papers: this item is included in nep-ban and nep-mac
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Working Paper: The Transmission of Shocks in EndogenousFinancial Networks: A Structural Approach (2019)
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