Financial Contagion and Network Analysis

Network models of interbank exposures allow the mapping of the complex web of financial linkages among many institutions and address issues of system stability and contagion risk. Although existing models cover a fair amount of ground in explaining how network structure can lead to default cascades and in quantifying the likelihood and the impact of default cascades through balance-sheet mechanics, the literature has shortcomings in explaining how shocks are potentially amplified through the network of exposures. These amplification mechanisms seem to be very important in financial crises. This review discusses the main conceptual ideas behind network models of contagion, the major findings of this literature, as well as some limitations of existing models.