Risk Contagion in Chinese Banking Industry: A Transfer Entropy-Based Analysis

What is the impact of a bank failure on the whole banking industry? To resolve this issue, the paper develops a transfer entropy-based method to determine the interbank exposure matrix between banks. This method constructs the interbank market structure by calculating the transfer entropy matrix using bank stock price sequences. This paper also evaluates the stability of Chinese banking system by simulating the risk contagion process. This paper contributes to the literature on interbank contagion mainly in two ways: it establishes a convincing connection between interbank market and transfer entropy, and exploits the market information (stock price) rather than presumptions to determine the interbank exposure matrix. Second, the empirical analysis provides an in depth understanding of the stability of the current Chinese banking system.