Time: 1.00 - 2.00pm Venue: Room 3.21, Old Building
Speaker: Matthew Pritsker (Boston Fed)
Seminar Title: Network Uncertainty and Interbank Markets
Abstract
This paper studies how the network of interbank connections, and uncertainty about those connections affects banks' perceived probabilities of default. The main result in the paper is a tractable formula for approximating how interbank connections affect banks probabilities of default when interconnections are known and small. Interconnections affect banks probabilities of default through two main channels, a ``valuation contagion'' channel in which the deterioration of the value of one banks' assets increases that banks credit risk, and the credit risk of those who have deposits with that bank. In addition, interconnections affect banks default probabilities through ``covariance contagion,'' in which the risk of a banks asset returns, and hence its credit risk, is affected by how its noninterbank assets co-vary with the return of its interbank assets. When interbank connections are not known, then unconditional probabilities of default are computed that account for uncertainty about the matrix of interbank connections. The analysis shows that all else equal interbank connections have larger effects on credit risk when banks are more financially distressed. That said, the very preliminary empirical analysis in the paper suggests that the variance of beliefs about interbank connections through the channels considered in this paper appears to have modest effects in realistic models.
The presentation slides can be found here.
