Networks of Financial Contagion

Banks develop relationships in order to protect themselves against liquidity risk. Despite this benefit, fragility of financial markets stems from these interconnections. A cornerstone in the microeconomic analysis of contagion in financial systems is the contribution of Allen and Gale (2000). Our work takes up the challenge of generalizing their contagion analysis to complex networks. We provide an effective procedure to construct a network of financial contagion which enables the analysis of complex networks via simulations. Our study shows that it is possible to find a minimal number of links to guarantee contagion resiliency, and that the Allen and Gale conjecture holds: the system becomes more fragile as the number of links decreases