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Heterogeneity, Correlations And Financial Contagion

Author

Listed:
  • FABIO CACCIOLI

    (Santa Fe Institute, 1399 Hyde Park Road, Santa Fe, NM 87501, USA)

  • THOMAS A. CATANACH

    (University of Notre Dame, Notre Dame, IN 46556, USA)

  • J. DOYNE FARMER

    (Santa Fe Institute, 1399 Hyde Park Road, Santa Fe, NM 87501, USA)

Abstract

We consider a model of contagion in financial networks recently introduced in Gai, P. and Kapadia, S. [Contagion in financial networks,Proc. R. Soc. A466(2120) (2010) 2401–2423], and we characterize the effect of a few features empirically observed in real networks on the stability of the system. Notably, we consider the effect of heterogeneous degree distributions, heterogeneous balance sheet size and degree correlations between banks. We study the probability of contagion conditional on the failure of a random bank, the most connected bank and the biggest bank, and we consider the effect of targeted policies aimed at increasing the capital requirements of a few banks with high connectivity or big balance sheets. Networks with heterogeneous degree distributions are shown to be more resilient to contagion triggered by the failure of a random bank, but more fragile with respect to contagion triggered by the failure of highly connected nodes. A power law distribution of balance sheet size is shown to induce an inefficient diversification that makes the system more prone to contagion events. A targeted policy aimed at reinforcing the stability of the biggest banks is shown to improve the stability of the system in the regime of high average degree. Finally, disassortative mixing, such as that observed in real banking networks, is shown to enhance the stability of the system.

Suggested Citation

  • Fabio Caccioli & Thomas A. Catanach & J. Doyne Farmer, 2012. "Heterogeneity, Correlations And Financial Contagion," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 15(supp0), pages 1-15.
    • Handle: RePEc:wsi:acsxxx:v:15:y:2012:i:supp0:n:s0219525912500580
    DOI: 10.1142/S0219525912500580
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    References listed on IDEAS

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    1. Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
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