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Working Paper

Recreating Banking Networks under Decreasing Fixed Costs

Theory emphasizes the central role of the structure of networks in the behavior of financial systems and their response to policy. Real-world networks, however, are rarely directly observable: Banks’ assets and liabilities are typically known, but not who is lending how much and to whom. We first show how to simulate realistic networks that are based on balance-sheet information by minimizing costs where there is a fixed cost to forming a link. Second, we also show how to do this for a model with fixed costs that are decreasing in the number of links. To approach the optimization problem, we develop a new algorithm based on the transportation planning literature. Computational experiments find that the resulting networks are not only consistent with the balance sheets, but also resemble real-world financial networks in their density (which is sparse but not minimally dense) and in their core-periphery and disassortative structure.

Suggested Citation

Maringer, Dietmar, Ben R. Craig, and Sandra Paterlini. 2019. “Recreating Banking Networks under Decreasing Fixed Costs” Federal Reserve Bank of Cleveland, Working Paper No. 19-21. https://doi.org/10.26509/frbc-wp-201921