Financial Contagion in the Laboratory: Does Network Structure Matter?

Date: 2016-06
By: John Duffy (Department of Economics, University of California-Irvine)
Aikaterini Karadimitropoulou (School of Economics, University of East Anglia)
Melanie Parravano (Business School, Newcastle University)
We design and report on laboratory experiments exploring the role of interbank network structure for the likelihood of a financial contagion. The laboratory provides us with the control necessary to precisely explore the role of different network configurations for the fragility of the financial system. Specifically, we study the likelihood of financial contagion in complete and incomplete networks of banks who are linked in terms of interbank deposits as in the model of Allen and Gale (2000). Subjects play the role of depositors who must decide whether or not to withdraw their funds from their bank. We find that financial contagions are possible under both network structures. While such contagions always occur under an incomplete interbank network structure, they are significantly less likely to occur under a complete interbank network structure where interbank linkages can effectively provide insurance against shocks to the system, and localize damage from the financial shock.
Keywords: Contagion; Networks; Experiments; Bank runs,; Interbank seposits; Financial fragility
JEL: C92 E44 G21

Too interconnected to fail: A survey of the interbank networks literature

Date: 2015
By: Hüser, Anne-Caroline
The banking system is highly interconnected and these connections can be conveniently represented as an interbank network. This survey presents a systematic overview of the recent advances in the theoretical literature on interbank networks. We assess our current understanding of the structure of interbank networks, of how network characteristics affect contagion in the banking system and of how banks form connections when faced with the possibility of contagion and systemic risk. In particular, we highlight how the theoretical literature on interbank networks offers a coherent way of studying interconnections, contagion processes and systemic risk, while emphasizing at the same time the challenges that must be addressed before general results on the link between the structure of the interbank network and financial stability can be established. The survey concludes with a discussion of the policy relevance of interbank network models with a special focus on macro-prudential policies and monetary policy.
Keywords: interbank networks,systemic risk,contagion,banking,macro-prudential policy
JEL: G21 E44 D85 G18 G01

An Experiment on the Causes of Bank Run Contagions

Date: 2012
By: Surajeet Chakravarty (Department of Economics, University of Exeter)
Miguel A. Fonseca (Department of Economics, University of Exeter)
Todd Kaplan (Department of Economics, University of Exeter)
To understand the mechanisms behind bank run contagions, we conduct bank run experiments in a modified Diamond-Dybvig setup with two banks (Left and Right). The banks’ liquidity levels are either linked or independent. Left Bank depositors see their bank’s liquidity level before deciding. Right Bank depositors only see Left Bank withdrawals before deciding. We find that Left Bank depositors’ actions signicantly affect Right Bank depositors’ behavior, even when liquidities are independent. Furthermore, a panic may be a one-way street: an increase in Left Bank withdrawals can cause a panic run on the Right Bank, but a decrease cannot calm markets.
Keywords: bank runs, contagion, experiment, multiple equilibria.
JEL: C72