Default clearing and ex-ante contagion in financial systems with a two-layer network structure

Abstract

Systemic risks do not arise only as a result of a crisis event, and it is important to understand the ex-ante risk contagion mechanisms. There has been no research on ex-ante contagion valuation and contagion modeling of multilayer networks. This study proposes the ex-ante-contagion mechanism of a two-layer network financial system with interbank lending connections and cross-holding connections, constructs a general valuation model of the financial system based on the Eisenberg and Noe clearing framework, and develops a model of ex-ante risk contagion and valuation functions. Stress tests further verify that bankruptcy is not a necessary condition for loss generation. By simulating different shock scenarios, we obtain the systemic risk and systemically important banks in China. Our models and analyses provide new research perspectives for studying risk contagion mechanisms in financial networks and offer empirical corroboration for regulators and policy makers.