Bank Contagion Risk Through Fire-Sales : A Heterogeneous Agent Model

This paper studies the impact of interbank risk exposures due to fire sales in the interbank lending market. We incorporate fire sale behaviors in a large-scale agent-based model that represents dynamic U.S. interbank lending system.We compare the simulated interbank networks with and without fire sales. The model shows that fire sales reduce the number of bank defaults due to financial shocks, while increasing the likelihood of contagion. Moreover, we investigate the implications of the capital requirements imposed by the Basel regulation by conducting a sensitivity test on capital ratios. We find the higher capital requirements may result in larger number of bank defaults