Risk Concentration in Networks of Banks Connected by Financial Contracts

Author: Nils Bundi

Advisor: Prof. Khaldoun Khashanah

Date: August, 2022
Department: Financial Engineering
Degree: Doctor of Philosophy

Advisory Committee:
Prof. Khaldoun Khashanah, Chairman
Prof. Wolfgang Breymann
Prof. Rupak Chatterjee
Prof. Majeed Simaan

Abstract

Interbank markets facilitate the redistribution of financial resources among banks and thus serve an important economic purpose. At the same time, these interactions form channels for the propagation of economic shocks and make the system more fragile in periods of financial stress. In order to better understand this phenomenon and design appropriate monetary policy options, current data limitations and model shortcomings have to be overcome. This dissertation contributes to the growing research body in three main areas. First, I address limitations in current network estimation techniques which are unable to preserve empirical network properties. I present a new methodology and show that it allows for the reconstruction of complex networks features. In a second essay, I discuss the shortcomings of contagion analyses based on static balance sheet data and a solvency criteria for bank failure. I propose an alternative approach that builds on timely and granular position-by-position data and discuss technological requirements to apply this on a large scale. The third essay studies the phenomenon of hidden contagion which is due to a latent process governing banks access to liquidity rather than direct bilateral exposures. I present new results that confirm a significant impact of such inherent shock propagation channels on the robustness of the interbank network. The dissertation concludes with a discussion of the overall results and suggestions for future research.

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