Interbank Debt Contagion and Financial Network Solvency (WP-2022-01)
This publication is a part of:
Collection: OCC Working Papers – New Frontiers in Bank Risk
I develop a stochastic model to analyze banks' default status in the network and network stability. I set up the loan creation rate and loan removal rate, coupled with the endogenous bank default rate in the model, to analyze the trajectory of surviving banks in the system. For both short-term and long-term equilibriums, I use a debt exposure Markov matrix to analyze solvency thresholds. I prove that my Markov process is ergodic and has a unique invariant stationary state. My shortest path algorithm demonstrates the efficacy of mitigating risk exposure in the network. Finally, I use Bank for International Settlements data to demonstrate the applicability of my model.