Abstract
We study a credit network and, in particular, an interbank system with an agent-based model. To understand the relationship between business cycles and cascades of bankruptcies, we model a three-sector economy with goods, credit and interbank market. In the interbank market, the participating banks share the risk of bad debits, which may potentially spread a bank’s liquidity problems through the network of banks. Our agent-based model sheds light on the correlation between bankruptcy cascades and the endogenous economic cycle of booms and recessions. It also demonstrates the serious trade-off between, on the one hand, reducing risks of individual banks by sharing them and, on the other hand, creating systemic risks through credit-related interlinkages of banks. As a result of our study, the dynamics underlying the meltdown of financial markets in 2008 becomes much better understandable.
Highlights
As economic literature has taught us in more than one occasion, there are many economic examples of situations in which mainstream theory, i.e., the Arrow-Debreu general equilibrium model, does not explain interactions between economic agents well
We believe that if we want to understand the dynamics of interactive market processes, and the emergent properties of the evolving market structures, it might pay to analyze explicitly how agents interact with each other, how information spreads through the market and how adjustments in disequilibrium take place
We explore the dynamic properties of the economic system modelled above by means of computer simulations
Summary
As economic literature has taught us in more than one occasion, there are many economic examples of situations in which mainstream theory, i.e., the Arrow-Debreu general equilibrium model, does not explain interactions between economic agents well. We believe that if we want to understand the dynamics of interactive market processes, and the emergent properties of the evolving market structures, it might pay to analyze explicitly how agents interact with each other, how information spreads through the market and how adjustments in disequilibrium take place. The recent vicissitudes of the credit market are a natural research issue to be analyzed with graph theory. If the banks were ‘‘isolated units’’, the bankruptcy of a borrower would be almost unimportant in the credit system. Given the strong interdependence in the interbank market, the default of one bank can bring about phenomena of financial contagion
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