Complexity and Crises in Financial Systems

We examine the role of macroeconomic ‡uctuations, asset market liquidity, and network structure in determining contagion and aggregate losses in a …nancial system. Systemic instability is explored in a …nancial network comprising three distinct, but interconnected, sets of agents – domestic banks, international …nancial institutions, and …rms. Calibrating the model to advanced country banking sector data, we obtain sensible aggregate loss distributions which are bimodal in nature. We demonstrate how systemic crises may occur and analyse how our results are in‡uenced by liquidity risk and bank heterogeneity. We conclude by discussing our model in the context of the ongoing …nancial crisis. Keywords : Systemic risk; Contagion; Network models; Financial crises. JEL Classi…cation Numbers : D85; G01; G21 Disclaimer: This paper represents the views of the authors and should not be thought to represent those of the Bank of England or Monetary Policy Committee members. Corresponding Author. Email : [email protected].