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Prof. Ester Faia

Goethe University Frankfurt, Germany

Authors: Marcel Bluhm, Ester Faia, and Jan Pieter Krahnen

Abstract: We develop a dynamic network model with heterogeneous banks which undertake optimizing portfolio decisions subject to liquidity and capital constraints and trade in the interbank market whose equilibrium is governed by a tatonnement process. Due to the micro-funded structure of the decisional process as well as the iterative dynamic adjustment taking place in the market, the links in the network structures are endogenous and evolve dynamically. We use the model to assess the diffusion of systemic risk, the contribution of each bank to it as well as the evolution of the network in response to financial shocks and across different prudential policy regimes.

Keywords: networks, complexity, tatonnement, contagion, marked to market.

Full Text:  “Endogenous Banks' Networks, Cascades and Systemic Risk”