Reconstructing and stress testing credit networks

Abstract

Financial networks are an important source of systemic risk, but often only partial network information is available. In this paper, we use data on bank-firm credit relationships in Japan and conduct a horse race between different network reconstruction methods in terms of their ability to reproduce the actual credit networks. We then compare the different reconstruction methods in terms of their implied levels of systemic risk based on a standard model of price-mediated contagion. We find that the observed credit network displays relatively high levels of systemic risk compared with most reconstruction methods. Lastly, we explore whether different policies can improve the robustness of the system.