Financial contagion in large, inhomogeneous stochastic interbank networks

Abstract

We consider the fraction of nodes that default in large, stochastic, inhomogeneous financial networks following an initial shock to the system. Results for deterministic sequences of networks are generalized to stochastic networks to account for interbank lending relationships that change frequently. A general class of inhomogeneous stochastic networks is proposed for use in systemic risk research, and we illustrate how results that hold for Erdős–Rényi networks can be generalized to the proposed network class. The network structure of a system is determined by interbank lending behavior which may vary according to the relative sizes of the banks. We then use the results of the paper to illustrate how network structure influences the systemic risk inherent in large banking systems.