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Working Paper

Filling in the Blanks: Network Structure and Interbank Contagion

This paper proposes an efficient method for estimating counterparty exposures in banking and financial markets. It combines information-theoretic arguments with economic incentives to produce more realistic interbank networks that preserve important characteristics of the original interbank market. The method loads the most probable links with the largest exposures consistent with the total lending and borrowing of each bank, yielding networks with minimum density. When used in a stress-testing context, the minimum-density solution overestimates contagion, whereas maximum entropy underestimates it. Using the two benchmarks side by side defines a useful range that bounds the cost of contagion in the true interbank network when counterparty exposures are unknown.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Anand, Kartik, Ben R. Craig, and Goetz von Peter. 2014. “Filling in the Blanks: Network Structure and Interbank Contagion.” Federal Reserve Bank of Cleveland, Working Paper No. 14-16.