Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns

Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may represent a channel for contagion as a bank default may spread to other banks through interbank linkages. This paper analyses how contagion propagates within the Italian interbank market using a unique d...

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Bibliographic Details
Published in:Journal of banking & finance 2011-05, Vol.35 (5), p.1114-1127
Main Author: Mistrulli, Paolo Emilio
Format: Article
Language:English
Subjects:
Bank liquidity
Bank loans
Bank management
Bank operations
Capitalization
Default
Entropy
Financial analysis
Financial contagion
Interbank market
Interbank market Financial contagion Systemic risk Maximum entropy
Italy
Liquidity
Loans
Maximum entropy
Maximum entropy method
Studies
Systemic risk
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Summary:Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may represent a channel for contagion as a bank default may spread to other banks through interbank linkages. This paper analyses how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Based on the availability of information on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banks’ capitalisation, the maximum entropy approach overrates the scope for contagion.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2010.09.018