Financial contagion in interbank network

Contagion effect is a key concern for banks charged with safeguarding overall financial stability and avoiding bankruptcy. In this paper, we investigate how the default contagion caused by a single bank's initial shock spread to its creditors and even the whole system, and how to estimate the contagion probability and contagion index, which reflects the impact on the rest of interbank system if one bank fails. By constructing the interbank network, we combine some parameters, such as net worth, leverage of outside assets and the network connectivity, to derive the explicit measures on the potential magnitude of interbank network effect on contagion with little detailed information. Results suggest that contagion effects are most significant if the originating bank is highly leveraged or has high network connectivity.